Current Liabilities AK II

Chapter
AP PHOTO/TOM GANNAM
11
Current Liabilities and Payroll
Panera Bread
B uying goods on credit is probably as old as business itself. In
fact, the ancient Babylonians were lending money to support
trade as early as 1300 b.c. The use of credit makes transactions more
United States, uses short-term trade credit, or accounts payable,
to purchase ingredients for making bread products in its bakeries.
Short-term trade credit gives Panera control over cash payments
convenient and improves buying power. For individuals, the most by separating the purchase function from the payment function.
common form of short-term credit is a credit card. Credit cards Thus, the employee responsible for purchasing the bakery ingredi-
allow individuals to purchase items before they are paid for, while ents is separated from the employee responsible for paying for the
removing the need for individuals to carry large amounts of cash. purchase. This separation of duties can help prevent unauthorized
They also provide documentation of purchases through a monthly purchases or payments.
credit card statement. In addition to accounts payable, a busi-
Short-term credit is also used by business like Panera Bread can also have cur-
nesses to make purchasing items for manufac- rent liabilities related to payroll, payroll taxes,
ture or resale more convenient, and gives the employee benefits, short-term notes, un-

business control over the payment for goods earned revenue, and contingencies. This chap-
and services. For example, Panera Bread, a ter discusses each of these types of current
chain of bakery-cafés located throughout the liabilities.
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Learning Objectives
After studying this chapter, you should be able to: Example Exercises
Describe and illustrate current liabilities related to accounts payable,
current portion of long-term debt, and notes payable.
Current Liabilities
Accounts Payable
Current Portion of Long-Term Debt
Short-Term Notes Payable EE 11-1
Determine employer liabilities for payroll, including liabilities arising from
employee earnings and deductions from earnings.
Payroll and Payroll Taxes
Liability for Employee Earnings
Deductions from Employee Earnings EE 11-2
Computing Employee Net Pay EE 11-3
Liability for Employer’s Payroll Taxes
Describe payroll accounting systems that use a payroll register, employee
earnings records, and a general journal.
Accounting Systems for Payroll and Payroll Taxes
Payroll Register EE 11-4, 11-5
Employee’s Earnings Record
Payroll Checks
Computerized Payroll System
Internal Controls for Payroll Systems
Journalize entries for employee fringe benefits, including vacation pay and pensions.
Employees’ Fringe Benefits
Vacation Pay
Pensions EE 11-6
Postretirement Benefits Other than Pensions
Current Liabilities on the Balance Sheet
Describe the accounting treatment for contingent liabilities and journalize
entries for product warranties.
Contingent Liabilities
Probable and Estimable EE 11-7
Probable and Not Estimable
Reasonably Possible
Remote
Describe and illustrate the use of the quick ratio in analyzing a company’s
ability to pay its current liabilities.
Financial Analysis and Interpretation: Quick Ratio EE 11-8
At a Glance 11 Page 514
Describe and Current Liabilities

illustrate current
liabilities related to When a company or a bank advances credit, it is making a loan. The company or
accounts payable, current
bank is called a creditor (or lender). The individuals or companies receiving the loan
portion of long-term debt,
are called debtors (or borrowers).
and notes payable.
Debt is recorded as a liability by the debtor. Long-term liabilities are debts due
beyond one year. Thus, a 30-year mortgage used to purchase property is a long-term
liability. Current liabilities are debts that will be paid out of current assets and are
due within one year.
Three types of current liabilities are discussed in this section—accounts payable,
the current portion of long-term debt, and short-term notes payable.
Accounts Payable
Accounts payable transactions have been described and illustrated in earlier chapters.
These transactions involved a variety of purchases on account, including the purchase
of merchandise and supplies. For most companies, accounts payable is the largest
current liability. Exhibit 1 shows the accounts payable balance as a percent of total
current liabilities for a number of companies.
Chapter 11 Current Liabilities and Payroll 493
Accounts Payable as a Exhibit 1

Percent of Total
Company Current Liabilities
Accounts Payable
as a Percent of Total
Alcoa Inc. 45%
Current Liabilities
AT&T 65
Gap Inc. 50
IBM 20
Rite Aid Corp. 54
Chevron Corp. 66
Current Portion of Long-Term Debt

Long-term liabilities are often paid back in periodic payments, called installments.
Such installments that are due within the coming year are classified as a current liabil-
ity. The installments due after the coming year are classified as a long-term liability.
To illustrate, The Coca-Cola Company reported the following debt payments schedule
in its December 31, 2011, annual report to shareholders (in millions):
Fiscal year ending

2012 $ 2,041
2013 1,515
2014 1,690
2015 1,462
2016 1,707
Thereafter 7,282
Total principal payments $15,697
The debt of $2,041 due in 2012 would be reported as a current liability on the
December 31 balance sheet for the preceding year. The remaining debt of $13,656
($15,697 – $2,041) would be reported as a long-term liability on the balance sheet.
Short-Term Notes Payable

Notes may be issued to purchase merchandise or other assets. Notes may also be
issued to creditors to satisfy an account payable created earlier.1
To illustrate, assume that Nature’s Sunshine Company issued a 90-day, 12% note
for $1,000, dated August 1, 2013, to Murray Co. for a $1,000 overdue account. The
entry to record the issuance of the note is as follows:
Aug. 1 Accounts Payable—Murray Co. 1,000

Notes Payable 1,000
Issued a 90-day, 12% note on account.
When the note matures, the entry to record the payment of $1,000 plus $30 inter-
est ($1,000 × 12% × 90/360) is as follows:
Oct. 30 Notes Payable 1,000

Interest Expense 30
Cash 1,030
Paid principal and interest due on note.
1 The accounting for notes received to satisfy an account receivable was described and illustrated in Chapter 9, Receivables.
494 Chapter 11 Current Liabilities and Payroll
The interest expense is reported in the Other Expense section of the income
statement for the year ended December 31, 2013. The interest expense account is
closed at December 31.
Each note transaction affects a debtor (borrower) and creditor (lender). The fol-
lowing illustration shows how the same transactions are recorded by the debtor and
creditor. In this illustration, the debtor (borrower) is Bowden Co., and the creditor
(lender) is Coker Co.
Bowden Co. (Borrower) Coker Co. (Creditor)
May 1. Bowden Co. purchased Merchandise Inventory 10,000 Accounts Receivable 10,000
merchandise on account from Accounts Payable 10,000 Sales 10,000
Coker Co., $10,000, 2/10, n/30.
The merchandise cost Coker Cost of Merchandise Sold 7,500
Co. $7,500. Merchandise Inventory 7,500
May 31. Bowden Co. issued a Accounts Payable 10,000 Notes Receivable 10,000
60-day, 12% note for $10,000 to Notes Payable 10,000 Accounts Receivable 10,000
Coker Co. on account.
July 30. Bowden Co. paid Notes Payable 10,000 Cash 10,200
Coker Co. the amount due on Interest Expense 200 Interest Revenue 200
the note of May 31. Interest: Cash 10,200 Notes Receivable 10,000
$10,000 × 12% × 60/360.
A company may also borrow from a bank by issuing a note. To illustrate, assume
that on September 19 Iceburg Company borrowed cash from First National Bank by
issuing a $4,000, 90-day, 15% note to the bank. The entry to record the issuance of
the note and the cash proceeds is as follows:
Sept. 19 Cash 4,000

Notes Payable 4,000
Issued a 90-day, 15% note to
First National Bank.
On the due date of the note (December 18), Iceburg Company owes First National
Bank $4,000 plus interest of $150 ($4,000 × 15% × 90/360). The entry to record the
payment of the note is as follows:
Dec. 18 Notes Payable 4,000

Interest Expense 150
Cash 4,150
Paid principal and interest due on note.
In some cases, a discounted note may be issued rather than an interest-bearing

note. A discounted note has the following characteristics:
1. The interest rate on the note is called the discount rate.
2. The amount of interest on the note, called the discount, is computed by multiplying
the discount rate times the face amount of the note.
3. The debtor (borrower) receives the face amount of the note less the discount, called
the proceeds.
4. The debtor must repay the face amount of the note on the due date.
To illustrate, assume that on August 10, Cary Company issues a $20,000, 90-day
discounted note to Western National Bank. The discount rate is 15%, and the amount
of the discount is $750 ($20,000 × 15% × 90/360). Thus, the proceeds received by
Cary Company are $19,250. The entry by Cary Company is as follows:
Aug. 10 Cash 19,250

Notes Payable 20,000
Issued a 90-day discounted note to Western
National Bank at a 15% discount rate.
The entry when Cary Company pays the discounted note on November 8 is as follows:2
Nov. 8 Notes Payable 20,000

Cash 20,000
Paid note due.
Other current liabilities that have been discussed in earlier chapters include ac-
crued expenses, unearned revenue, and interest payable. The accounting for wages
and salaries, termed payroll accounting, is discussed next.
Example Exercise 11-1 Proceeds from Notes Payable

On July 1, Bella Salon Company borrowed cash from Best Bank by issuing a 60-day note with a face amount
of $60,000.
a. Determine the proceeds of the note, assuming the note carries an interest rate of 6%.
b. Determine the proceeds of the note, assuming the note is discounted at 6%.
Follow My Example 11-1

a. $60,000
b. $59,400 [$60,000 – ($60,000 × 6% × 60/360)]
Practice Exercises: PE 11-1A, PE 11-1B
Payroll and Payroll Taxes Determine

employer liabilities
for payroll, including
In accounting, payroll refers to the amount paid to employees for services they pro-
liabilities arising from
vided during the period. A company’s payroll is important for the following reasons:
employee earnings and
1. Payroll and related payroll taxes significantly affect the net income of most companies. deductions from earnings.
2. Payroll is subject to federal and state regulations.
3. Good employee morale requires payroll to be paid timely and accurately.
Liability for Employee Earnings

Note:
Salary usually refers to payment for managerial and administrative services. Salary is Employee salaries and
normally expressed in terms of a month or a year. Wages usually refers to payment wages are
for employee manual labor. The rate of wages is normally stated on an hourly or expenses to an
a weekly basis. The salary or wage of an employee may be increased by bonuses, employer.
commissions, profit sharing, or cost-of-living adjustments.
2 If the accounting period ends before a discounted note is paid, an adjusting entry should record the prepaid (deferred) interest
that is not yet an expense. This deferred interest would be deducted from Notes Payable in the Current Liabilities section of the
balance sheet.
Companies engaged in interstate commerce must follow the Fair Labor Standards Act.
This act, sometimes called the Federal Wage and Hour Law, requires employers to pay
a minimum rate of 1½ times the regular rate for all hours worked in excess of 40 hours
per week. Exemptions are provided for executive, administrative, and some supervisory
positions. Increased rates for working overtime, nights, or holidays are common, even
when not required by law. These rates may be as much as twice the regular rate.
To illustrate computing an employee’s earnings, assume that John T. McGrath is
a salesperson employed by McDermott Supply Co. McGrath’s regular rate is $34 per
hour, and any hours worked in excess of 40 hours per week are paid at 1½ times
the regular rate. McGrath worked 42 hours for the week ended December 27. His
earnings of $1,462 for the week are computed as follows:
Earnings at regular rate (40 hrs. × $34) $1,360
Earnings at overtime rate [2 hrs. × ($34 × 1½)] 102
Total earnings $1,462
Deductions from Employee Earnings

The total earnings of an employee for a payroll period, including any overtime pay, are
called gross pay. From this amount is subtracted one or more deductions to arrive at
the net pay. Net pay is the amount paid the employee. The deductions normally include
federal, state, and local income taxes, medical insurance, and pension contributions.
Income Taxes Employers normally withhold a portion of employee earnings for pay-
ment of the employees’ federal income tax. Each employee authorizes the amount to be
withheld by completing an “Employee’s Withholding Allowance Certificate,” called a W-4.
Exhibit 2 is the W-4 form submitted by John T. McGrath.
On the W-4, an employee indicates marital status and the number of withhold-
ing allowances. A single employee may claim one withholding allowance. A married
employee may claim an additional allowance for a spouse. An employee may also
claim an allowance for each dependent other than a spouse. Each allowance reduces
the federal income tax withheld from the employee’s pay. Exhibit 2 indicates that
John T. McGrath is single and, thus, claimed one withholding allowance.
The federal income tax withheld depends on each employee’s gross pay and W-4
allowance. Withholding tables issued by the Internal Revenue Service (IRS) are used
to determine amounts to withhold. Exhibit 3 is an example of an IRS wage withhold-
ing table for a single person who is paid weekly.3
Exhibit 2
Separate here and give Form W-4 to your employer. Keep the top part for your records.
Employee’s
Withholding Form W-4
Department of the Treasury
Employee's Withholding Allowance Certificate
▶ Whether you are entitled to claim a certain number of allowances or exemption from withholding is
OMB No. 1545-0074
2013
subject to review by the IRS. Your employer may be required to send a copy of this form to the IRS.
Allowance Internal Revenue Service
1 Your first name and middle initial Last name 2 Your social security number
Certificate John T. McGrath 381 48 9120

Home address (number and street or rural route) X Single
(W-4 Form) 1830 4th Street
3 Married Married, but withhold at higher Single rate.
Note. If married, but legally separated, or spouse is a nonresident alien, check the “Single” box.
City or town, state, and ZIP code
4 If your last name differs from that shown on your social security card,
Clinton, Iowa 52732-6142 check here. You must call 1-800-772-1213 for a replacement card. ▶
5 Total number of allowances you are claiming (from line H above or from the applicable worksheet on page 2) 5
6 Additional amount, if any, you want withheld from each paycheck . . . . . . . . . . . . . . 6 $
7 I claim exemption from withholding for 2012, and I certify that I meet both of the following conditions for exemption.
• Last year I had a right to a refund of all federal income tax withheld because I had no tax liability, and
• This year I expect a refund of all federal income tax withheld because I expect to have no tax liability.
If you meet both conditions, write “Exempt” here . . . . . . . . . . . . . . . ▶ 7
Under penalties of perjury, I declare that I have examined this certificate and, to the best of my knowledge and belief, it is true, correct, and complete.
Employee’s signature
(This form is not valid unless you sign it.) ▶ Date ▶ June 2, 2012
8 Employer’s name and address (Employer: Complete lines 8 and 10 only if sending to the IRS.) 9 Office code (optional) 10 Employer identification number (EIN)
For Privacy Act and Paperwork Reduction Act Notice, see page 2. Cat. No. 10220Q Form W-4 (2012)
3 IRS withholding tables are also available for married employees and for pay periods other than weekly.
In Exhibit 3, each row is the employee’s wages after deducting the employee’s
withholding allowances. Each year, the amount of the standard withholding allowance
is determined by the IRS. For ease of computation and because this amount changes
each year, we assume that the standard withholding allowance to be deducted in
Exhibit 3 for a single person paid weekly is $70.4 Thus, if two withholding allow-
ances are claimed, $140 ($70 × 2) is deducted.
To illustrate, John T. McGrath made $1,462 for the week ended December 27.
McGrath’s W-4 claims one withholding allowance of $70. Thus, the wages used in
determining McGrath’s withholding bracket in Exhibit 3 are $1,392 ($1,462 – $70).
After the person’s withholding wage bracket has been computed, the federal in-
come tax to be withheld is determined as follows:
Step 1. Locate the proper withholding wage bracket in Exhibit 3.
McGrath’s wages after deducting one standard IRS withholding allowance
are $1,392 ($1,462 – $70). Therefore, the wage bracket for McGrath is
$704–$1,648.
Step 2. Compute the withholding for the proper wage bracket using the directions
in the two right-hand columns in Exhibit 3.
For McGrath’s wage bracket, the withholding is computed as “$91.40 plus
25% of the excess over $704.” Hence, McGrath’s withholding is $263.40, as
shown below.
Initial withholding from wage bracket $ 91.40
Plus [25% × ($1,392 – $704)] 172.00
Total withholding $263.40
Table for Percentage Method of Withholding WEEKLY Payroll Period

Exhibit 3
(a) SINGLE person (including head of household)— Wage Bracket
If the amount of wages (after Withholding Table
subtracting withholding allowances) The amount of income tax
is: to withhold is:
Not over $40 . . . . . . . . . . . . . . . . . . . . .$0
Over— But not over— of excess over—
$40 —$204 . . . $0.00 plus 10% —$40
$204 —$704 . . . $16.40 plus 15% —$204
$704 —$1,648 . . . $91.40 plus 25% —$704 McGrath wage bracket
$1,648 —$3,394 . . . $327.40 plus 28% —$1,648
$3,394 —$7,332 . . . $816.28 plus 33% —$3,394
$7,332 . . . . . . . . . . . . . . . $2,115.82 plus 35% —$7,332
Source: Publication 15, Employer’s Tax Guide, Internal Revenue Service, 2011.
Residents of New York

City must pay federal,
Employers may also be required to withhold state or city income taxes. The state, and city income
amounts to be withheld are determined on state-by-state and city-by-city bases. taxes.
Example Exercise 11-2 Federal Income Tax Withholding

Karen Dunn’s weekly gross earnings for the present week were $2,250. Dunn has two exemptions. Using the wage bracket
withholding table in Exhibit 3 with a $70 standard withholding allowance for each exemption, what is Dunn’s federal
income tax withholding?
(continued)
4 The actual IRS standard withholding allowance changes every year and was $73.08 for 2012.

Total wage payment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,250
One allowance (provided by IRS). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $70
Multiplied by allowances claimed on Form W-4 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ×2 140
Amount subject to withholding. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,110
Initial withholding from wage bracket in Exhibit 3. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $327.40

Plus additional withholding: 28% of excess over $1,648 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129.36*
Federal income tax withholding. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $456.76
*28% × ($2,110 – $1,648)
FICA Tax Employers are required by the Federal Insurance Contributions Act (FICA) to
withhold a portion of the earnings of each employee. The FICA tax withheld contributes
to the following two federal programs:
1. Social security, which provides payments for retirees, survivors, and disability i nsurance.
2. Medicare, which provides health insurance for senior citizens.
The amount withheld from each employee is based on the employee’s earnings
paid in the calendar year. The withholding tax rates and maximum earnings subject
to tax are often revised by Congress.5 To simplify, this chapter assumes the following
rates and earnings subject to tax:
1. Social security: 6% on all earnings
2. Medicare: 1.5% on all earnings
To illustrate, assume that John T. McGrath’s earnings for the week ending Decem-
ber 27 are $1,462 and the total FICA tax to be withheld is $109.65, as shown below.
Earnings subject to 6% social security tax. . . . . . . . . . . . . . . . . . . . . . . . . . $1,462

Social security tax rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . × 6%
Social security tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 87.72
Earnings subject to 1.5% Medicare tax. . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,462

Medicare tax rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . × 1.5%
Medicare tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21.93
Total FICA tax. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $109.65
Other Deductions Employees may choose to have additional amounts deducted from
their gross pay. For example, an employee may authorize deductions for retirement sav-
ings, for charitable contributions, or life insurance. A union contract may also require the
deduction of union dues.
Computing Employee Net Pay

Gross earnings less payroll deductions equals net pay, sometimes called take-home
pay. Assuming that John T. McGrath authorized deductions for retirement savings and
5 For 2012, the social security tax rate was 6.2% and the Medicare tax rate was 1.45%. Earnings subject to the social security tax are
limited to an annual threshold amount; but for text examples and problems, assume all accumulated annual earnings are below this
threshold and subject to the tax.
for a United Fund contribution, McGrath’s net pay for the week ended December 27
is $1,063.95, as shown below.
Gross earnings for the week $1,462.00
Deductions:
Social security tax $ 87.72
Medicare tax 21.93
Federal income tax 263.40
Retirement savings 20.00
United Fund 5.00
Total deductions 398.05
Net pay $1,063.95
Example Exercise 11-3 Employee Net Pay

Karen Dunn’s weekly gross earnings for the week ending December 3 were $2,250, and her federal income tax withholding
was $456.76. Assuming the social security rate is 6% and Medicare is 1.5%, what is Dunn’s net pay?

Total wage payment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,250.00
Less: Federal income tax withholding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $456.76
Social security tax ($2,250 × 6%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 135.00
Medicare tax ($2,250 × 1.5%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33.75 625.51
Net pay . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,624.49
Liability for Employer’s Payroll Taxes

Employers are subject to the following payroll taxes for amounts paid their employees:
1. FICA Tax: Employers must match the employee’s FICA tax contribution.
2. Federal Unemployment Compensation Tax (FUTA): This employer tax provides for
temporary payments to those who become unemployed. The tax collected by the
federal government is allocated among the states for use in state programs rather than
paid directly to employees. Congress often revises the FUTA tax rate and maximum
earnings subject to tax.
3. State Unemployment Compensation Tax (SUTA): This employer tax also provides tem-
porary payments to those who become unemployed. The FUTA and SUTA programs
are closely coordinated, with the states distributing the unemployment checks.6 SUTA
tax rates and earnings subject to tax vary by state.7
The preceding employer taxes are an operating expense of the company. Exhibit 4
summarizes the responsibility for employee and employer payroll taxes.
Exhibit 4
Responsibility for
Tax Payments
© Cengage Learning 2014
6 This rate may be reduced to 0.8% for credits for state unemployment compensation tax.
7 For 2012, the maximum state rate credited against the federal unemployment rate was 5.4% of the first $7,000 of each employee’s
earnings during a calendar year.
Business Connection
The Most you Will Ever Pay . . . Beginning in 1940 you will pay, and your employer will
pay, 1½ cents for each dollar you earn, up to $3,000 a year . . .
In 1936, the Social Security Board described how the tax and then beginning in 1943, you will pay 2 cents, and so will your
was expected to affect a worker’s pay, as follows: employer, for every dollar you earn for the next three years. After
that, you and your employer will each pay half a cent more for
The taxes called for in this law will be paid both by your 3 years, and finally, beginning in 1949, . . . you and your employer
employer and by you. For the next 3 years you will pay will each pay 3 cents on each dollar you earn, up to $3,000 a year.
maybe 15 cents a week, maybe 25 cents a week, maybe That is the most you will ever pay.
30 cents or more, according to what you earn. That is to
The rate on January 1, 2012, was 7.65 cents per dollar
say, during the next 3 years, beginning January 1, 1937,
earned (7.65%). The social security portion was 6.20% on
you will pay 1 cent for every dollar you earn, and at the
the first $110,100 of earnings. The Medicare portion was
same time your employer will pay 1 cent for every dollar
1.45% on all earnings.*
you earn, up to $3,000 a year. . . .
*For the first two months of 2012, the social security tax rate was reduced by 2 percentage points for employees and for self-employed workers.
Source: Arthur Lodge, “That Is the Most You Will Ever Pay,” Journal of Accountancy, October 1985, p. 44.
Describe payroll Accounting Systems for Payroll

accounting
systems that use a payroll and Payroll Taxes
register, employee earnings
records, and a general Payroll systems should be designed to:
journal.
1. Pay employees accurately and timely.
2. Meet regulatory requirements of federal, state, and local agencies.
3. Provide useful data for management decision-making needs.
Although payroll systems differ among companies, the major elements of most
payroll systems are:
1. Payroll register
2. Employee’s earnings record
3. Payroll checks
Payroll Register
The payroll register is a multicolumn report used for summarizing the data for each
payroll period. Although payroll registers vary by company, a payroll register normally
includes the following columns:
1. Employee name 8. Federal income tax withheld
2. Total hours worked 9. Retirement savings withheld
3. Regular earnings 10. Miscellaneous items withheld
4. Overtime earnings 11. Total withholdings
5. Total gross earnings 12. Net pay
6. Social security tax withheld 13. Check number of payroll check issued
7. Medicare tax withheld 14. Accounts debited for payroll expense
Exhibit 5 on pages 502–503 illustrates a payroll register. The two right-hand col-
umns of the payroll register indicate the accounts debited for the payroll expense.
These columns are often referred to as the payroll distribution.
Recording Employees’ Earnings The column totals of the payroll register provide
the basis for recording the journal entry for payroll. The entry based on the payroll register
Note: in Exhibit 5 is shown at the top of the next page.
Payroll taxes become
a liability to the Recording and Paying Payroll Taxes Payroll taxes are recorded as liabilities when
employer when the the payroll is paid to employees. In addition, employers compute and report payroll taxes
payroll is paid. on a calendar-year basis, which may differ from the company’s fiscal year.
Dec. 27 Sales Salaries Expense 11,122.00

Office Salaries Expense 2,780.00
Social Security Tax Payable 834.12
Medicare Tax Payable 208.53
Employees Federal Income Tax Payable 3,332.00
Retirement Savings Deductions Payable 680.00
United Fund Deductions Payable 520.00
Salaries Payable 8,327.35
Payroll for week ended December 27.
Example Exercise 11-4 Journalize Period Payroll

The payroll register of Chen Engineering Services indicates $900 of social security withheld and $225 of Medicare tax
withheld on total salaries of $15,000 for the period. Federal withholding for the period totaled $2,925.
Provide the journal entry for the period’s payroll.

Salaries Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,000
Social Security Tax Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 900
Medicare Tax Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 225
Employees Federal Income Tax Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,925
Salaries Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,950
On December 27, McDermott Supply has the following payroll data:

Sales salaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $11,122
Office salaries owed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,780
Wages owed employees on December 27 . . . . . . . . . . . . . . $13,902
Wages subject to payroll taxes:
Social security tax (6%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $13,902
Medicare tax (1.5%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13,902
State (5.4%) and federal (0.8%)
unemployment compensation tax . . . . . . . . . . . . . . . . . . . 2,710
Employers must match the employees’ social security and Medicare tax con-
tributions. In addition, the employer must pay state unemployment compensa-
tion tax (SUTA) of 5.4% and federal unemployment compensation tax (FUTA) of
0.8%. When payroll is paid on December 27, these payroll taxes are computed
as follows:
Social security tax $ 834.12 ($13,902 × 6%, and from Social Security Tax column of Exhibit 5)
Medicare tax 208.53 ($13,902 × 1.5%, and from Medicare Tax column of Exhibit 5)
SUTA 146.34 ($2,710 × 5.4%)
FUTA 21.68 ($2,710 × 0.8%)
Total payroll taxes $1,210.67
The entry to journalize the payroll tax expense for Exhibit 5 is shown below.
Dec. 27 Payroll Tax Expense 1,210.67

Social Security Tax Payable 834.12
Medicare Tax Payable 208.53
State Unemployment Tax Payable 146.34
Federal Unemployment Tax Payable 21.68
Payroll taxes for week ended December 27.
Exhibit 5 Payroll Register
Earnings
Employee Name Total Hours Regular Overtime Total

1 Abrams, Julie S. 40 500.00 500.00 1
2 Elrod, Fred G. 44 392.00 58.80 450.80 2
3 Gomez, Jose C. 40 840.00 840.00 3
4 McGrath, John T. 42 1,360.00 102.00 1,462.00 4
24 24
5 5
25 Wilkes, Glenn K. 40 480.00 480.00 25

26 Zumpano, Michael W. 40 600.00 600.00 26
27 Total 13,328.00 574.00 13,902.00 27
28 28
The preceding entry records a liability for each payroll tax. When the payroll taxes are
paid, an entry is recorded debiting the payroll tax liability accounts and crediting Cash.
Example Exercise 11-5 Journalize Payroll Tax

The payroll register of Chen Engineering Services indicates $900 of social security withheld and $225 of Medicare tax
withheld on total salaries of $15,000 for the period. Earnings of $5,250 are subject to state and federal unemployment
compensation taxes at the federal rate of 0.8% and the state rate of 5.4%.
Provide the journal entry to record the payroll tax expense for the period.

Payroll Tax Expense................................................................................................................... 1,450.50
Social Security Tax Payable.............................................................................................. 900.00
Medicare Tax Payable......................................................................................................... 225.00
State Unemployment Tax Payable................................................................................ 283.50*
Federal Unemployment Tax Payable............................................................................ 42.00**
*$5,250 × 5.4%
**$5,250 × 0.8%
Employee’s Earnings Record

Each employee’s earnings to date must be determined at the end of each payroll
period. This total is necessary for computing the employee’s social security tax with-
holding and the employer’s payroll taxes. Thus, detailed payroll records must be kept
for each employee. This record is called an employee’s earnings record.
Exhibit 6, on pages 504–505, shows a portion of John T. McGrath’s employee’s
earnings record. An employee’s earnings record and the payroll register are inter-
related. For example, McGrath’s earnings record for December 27 can be traced to
the fourth line of the payroll register in Exhibit 5.
As shown in Exhibit 6, an employee’s earnings record has quarterly and yearly
totals. These totals are used for tax, insurance, and other reports. For example, one
such report is the Wage and Tax Statement, commonly called a W-2. This form is
E x h i b i t 5 (Concluded)
Deductions Withheld Paid Accounts Debited

Social Federal Sales Office
Security Medicare Income Retirement Net Check Salaries Salaries
Tax Tax Tax Savings Misc. Total Pay No. Expense Expense
1 30.00 7.50 50.30 20.00 UF 10.00 117.80 382.20 6857 500.00 1
2 27.05 6.76 42.92 UF 50.00 126.73 324.07 6858 450.80 2
3 50.40 12.60 107.90 25.00 UF 10.00 205.90 634.10 6859 840.00 3
4 87.72 21.93 263.40 20.00 UF 5.00 398.05 1,063.95 6860 1,462.00 4
24 24
5 5
25 28.80 7.20 47.30 10.00 93.30 386.70 6880 480.00 25

26 36.00 9.00 65.30 5.00 UF 2.00 117.30 482.70 6881 600.00 26
27 834.12 208.53 3,332.00 680.00 UF 520.00 5,574.65 8,327.35 11,122.00 2,780.00 27
28 28
Miscellaneous Deductions: UF––United Fund
provided annually to each employee as well as to the Social Security Administration.

The W-2 shown below is based on John T. McGrath’s employee’s earnings record
shown in Exhibit 6, on pages 504–505.
a Employee’s social security number For Official Use Only ▶

22222 Void
381-48-9120 OMB No. 1545-0008
b Employer identification number (EIN) 1 Wages, tips, other compensation 2 Federal income tax withheld
61-8436524 100,500.00 21,387.65
c Employer’s name, address, and ZIP code 3 Social security wages 4 Social security tax withheld
McDermott Supply Co. 100,500.00 6,030.00

415 5th Ave. So. 5 Medicare wages and tips 6 Medicare tax withheld
Dubuque, IA 52736-0142
100,500.00 1,507.50
7 Social security tips 8 Allocated tips
d Control number 9 10 Dependent care benefits
e Employee’s first name and initial Last name Suff. 11 Nonqualified plans 12a See instructions for box 12
C
o
John T. McGrath d
e
13 Statutory Retirement Third-party 12b
employee plan sick pay
1830 4th St. C
o
d
Clinton, IA 52732-6142 e
14 Other 12c
C
o
d
e
12d
C
o
d
e
f Employee’s address and ZIP code

15 State Employer’s state ID number 16 State wages, tips, etc. 17 State income tax 18 Local wages, tips, etc. 19 Local income tax 20 Locality name
IA Dubuque
Form W-2 Wage and Tax Statement

Copy A For Social Security Administration — Send this entire page with
2013 Department of the Treasury—Internal Revenue Service
For Privacy Act and Paperwork Reduction
Act Notice, see the separate instructions.
Form W-3 to the Social Security Administration; photocopies are not acceptable. Cat. No. 10134D
Do Not Cut, Fold, or Staple Forms on This Page
Payroll Checks
Companies may pay employees, especially part-time employees, by issuing payroll
checks. Each check includes a detachable statement showing how the net pay was
computed. Exhibit 7, on page 506, illustrates a payroll check for John T. McGrath.
Most companies issuing payroll checks use a special payroll bank account. In
such cases, payroll is processed as follows:
1. The total net pay for the period is determined from the payroll register.
2. The company authorizes an electronic funds transfer (EFT) from its regular bank ac-
count to the special payroll bank account for the total net pay.
3. Individual payroll checks are written from the payroll account.
4. The numbers of the payroll checks are inserted in the payroll register.
Exhibit 6
John T. McGrath
Employee’s 1830 4th St.
Earnings Record Clinton, IA 52732-6142 PHONE: 555-3148
SINGLE NUMBER OF
WITHHOLDING PAY
ALLOWANCES: 1 RATE: $1,360.00 Per Week
OCCUPATION: Salesperson EQUIVALENT HOURLY RATE: $34
Earnings
Total Regular Overtime Total

Period Ending Hours Earnings Earnings Earnings Total
41
1 41
1
42 SEPT. 27 53 1,360.00 663.00 2,023.00 75,565.00 42
43 THIRD QUARTER 17,680.00 7,605.00 25,285.00 43
44 OCT. 4 51 1,360.00 561.00 1,921.00 77,486.00 44
49
45 49
45
50 NOV. 15 50 1,360.00 510.00 1,870.00 89,382.00 50
51 NOV. 22 53 1,360.00 663.00 2,023.00 91,405.00 51
52 NOV. 29 47 1,360.00 357.00 1,717.00 93,122.00 52
53 DEC. 6 53 1,360.00 663.00 2,023.00 95,145.00 53
54 DEC.13 52 1,360.00 612.00 1,972.00 97,117.00 54

55 DEC. 20 51 1,360.00 561.00 1,921.00 99,038.00 55
56 DEC. 27 42 1,360.00 102.00 1,462.00 100,500.00 56
57 FOURTH QUARTER 17,680.00 7,255.00 24,935.00 57
58 YEARLY TOTAL 70,720.00 29,780.00 100,500.00 58
An advantage of using a separate payroll bank account is that reconciling the

bank statements is simplified. In addition, a payroll bank account establishes control
over payroll checks and, thus, prevents their theft or misuse.
Many companies use electronic funds transfer to pay their employees. In such
cases, each pay period an employee’s net pay is deposited directly into the employee
checking account. Later, employees receive a payroll statement summarizing how the
net pay was computed.
Computerized Payroll System

The inputs into a payroll system may be classified as:
1. Constants, which are data that remain unchanged from payroll to payroll.
Examples: Employee names, social security numbers, marital status, number of income
tax withholding allowances, rates of pay, tax rates, and withholding tables.
2. Variables, which are data that change from payroll to payroll.
Examples: Number of hours or days worked for each employee, accrued days of sick
leave, vacation credits, total earnings to date, and total taxes withheld.
In a computerized accounting system, constants are stored within a payroll file. The
variables are input each pay period by a payroll clerk. In some systems, employees
swipe their identification (ID) cards when they report for and leave from work. In
such cases, the hours worked by each employee are automatically updated.
A computerized payroll system also maintains electronic versions of the payroll
register and employee earnings records. Payroll system outputs, such as payroll
checks, EFTs, and tax records, are automatically produced each pay period.
E x h i b i t 6 (Concluded)
SOC. SEC. NO.: 381-48-9120 EMPLOYEE NO.: 814
DATE OF BIRTH: February 15, 1982
DATE EMPLOYMENT TERMINATED:
Deductions Paid
Social Federal
Security Medicare Income Retirement Net Check
Tax Tax Tax Savings Other Total Amount No.
41
42 121.38 30.35 412.80 20.00 584.53 1,438.47 6175 42
43 1,517.10 379.28 5,391.71 260.00 UF 40.00 7,588.09 17,696.91 43
44 115.26 28.82 384.24 20.00 548.32 1,372.68 6225 44
49
4
50 112.20 28.05 369.96 20.00 530.21 1,339.79 6530 50
51 121.38 30.35 412.80 20.00 589.53 1,433.47 6582 51
52 103.02 25.76 327.15 20.00 475.93 1,241.07 6640 52
53 121.38 30.35 412.80 20.00 UF 5.00 584.53 1,438.47 6688 53
54 118.32 29.58 398.52 20.00 566.42 1,405.58 6743 54

55 115.26 28.82 384.24 20.00 548.32 1,372.68 6801 55
56 87.72 21.93 263.40 20.00 UF 5.00 398.05 1,063.95 6860 56
57 1,496.10 374.03 5,293.71 260.00 UF 15.00 7,438.84 17,496.16 57
58 6,030.00 1,507.50 21,387.65 1,040.00 UF 100.00 30,065.15 70,434.85 58
Internal Controls for Payroll Systems

The cash payment controls described in Chapter 8, Sarbanes-Oxley, Internal Control, and
Cash, also apply to payrolls. Some examples of payroll controls include the following:
1. If a check-signing machine is used, blank payroll checks and access to the machine
should be restricted to prevent their theft or misuse.
2. The hiring and firing of employees should be properly authorized and approved in writing.
3. All changes in pay rates should be properly authorized and approved in writing.
4. Employees should be observed when arriving for work to verify that employees are
“checking in” for work only once and only for themselves. Employees may “check
in” for work by using a time card or by swiping their employee ID card.
5. Payroll checks should be distributed by someone other than employee supervisors.
6. A special payroll bank account should be used.
Integrity, Objectivity, and Ethics in Business

$8 Million for 18 Minutes of Work
Computer system controls can be very important in issu- software. After six days, the error was discovered and the
ing payroll checks. In one case, a Detroit schoolteacher money was returned. “One of the things that came with
was paid $4,015,625 after deducting $3,884,375 in payroll (the software) is a fail-safe that prevents that. It doesn’t
deductions for 18 minutes of overtime work. The error work,” a financial officer said. The district has since in-
was caused by a computer glitch when the teacher’s em- stalled a program to flag any paycheck exceeding $10,000.
ployee identification number was substituted incorrectly
in the “hourly wage” field and wasn’t caught by the payroll Source: Associated Press, September 27, 2002.
Exhibit 7
S
Check Number: 6860
McDermott Supply Co. Pay Period Ending: 12/27/13
Payroll Check 415 5th Ave. So.
John T. McGrath
1830 4th St.
Dubuque, IA 52736-0142 Clinton, IA 52732-6142
HOURS & EARNINGS TAXES & DEDUCTIONS

CURRENT Y-T-D
DESCRIPTION AMOUNT DESCRIPTION AMOUNT AMOUNT
Rate of Pay Reg. 34 Social Security Tax 87.72 6,030.00
Rate of Pay O.T. 51 Medicare Tax 21.93 1,507.50
Hours Worked Reg. 40 Fed. Income Tax 263.40 21,387.65
Hours Worked O.T. 2 U.S. Savings Bonds 20.00 1,040.00
United Fund 5.00 100.00
Net Pay 1,063.95
Total Gross Pay 1,462.00 Total 398.05 30,365.15

Total Gross Y-T-D 100,500.00
STATEMENT OF EARNINGS. DETACH AND KEEP FOR YOUR RECORDS
S
LaGesse Savings & Loan
McDermott Supply Co.
33 Katie Avenue, Suite 33
415 5th Ave. So. Clinton, IA 52736-3581
Dubuque, IA 52736-0142 24-2/531
Pay Period Ending: 12/27/13 6860
ONE THOUSAND SIXTY-THREE AND 95/100 . . . . . . . . . . . . . . DOLLARS

PAY .
To the JOHN T. MCGRATH $1,063.95
Order of 1830 4TH ST.
CLINTON, IA 52732-6142
6860 153111123 9385402
Journalize entries Employees’ Fringe Benefits

for employee
fringe benefits, including
Many companies provide their employees benefits in addition to salary and wages
vacation pay and pensions.
earned. Such fringe benefits may include vacation, medical, and retirement benefits.
The cost of employee fringe benefits is recorded as an expense by the
employer. To match revenues and expenses, the estimated cost of fringe benefits
is recorded as an expense during the period in which the employees earn the
benefits.
Vacation Pay
Note: Most employers provide employees vacations, sometimes called compensated ab-
Vacation pay becomes sences. The liability to pay for employee vacations could be accrued as a liability at
the employer’s liability the end of each pay period. However, many companies wait and record an adjusting
as the employee earns
vacation rights.
entry for accrued vacation at the end of the year.
To illustrate, assume that employees earn one day of vacation for each month
worked. The estimated vacation pay for the year ending December 31 is $325,000.
The adjusting entry for the accrued vacation is shown below.
Dec. 31 Vacation Pay Expense 325,000

Vacation Pay Payable 325,000
Accrued vacation pay for the year.
Employees may be required to take all their vacation time within one year. In
such cases, any accrued vacation pay will be paid within one year. Thus, the vacation
pay payable is reported as a current liability on the balance sheet. If employees are
allowed to accumulate their vacation pay, the estimated vacation pay payable that
will not be taken within a year is reported as a long-term liability.
When employees take vacations, the liability for vacation pay is decreased by deb-
iting Vacation Pay Payable. Salaries or Wages Payable and the other related payroll
accounts for taxes and withholdings are credited.
Pensions
A pension is a cash payment to retired employees. Pension rights are accrued by
employees as they work, based on the employer’s pension plan. Two basic types of
pension plans are:
1. Defined contribution
2. Defined benefit
In a defined contribution plan, the company invests contributions on behalf of
the employee during the employee’s working years. Normally, the employee and
employer contribute to the plan. The employee’s pension depends on the total con-
tributions and the investment returns earned on those contributions.
One of the more popular defined contribution plans is the 401k plan. Under
this plan, employees contribute a portion of their gross pay to investments, such as
mutual funds. A 401k plan offers employees two advantages.
1. The employee contribution is deducted before taxes.
2. The contributions and related earnings are not taxed until withdrawn at retirement.
In most cases, the employer matches some portion of the employee’s contribu-
tion. The employer’s cost is debited to Pension Expense. To illustrate, assume that
Heaven Scent Perfumes Company contributes 10% of employee monthly salaries to
an employee 401k plan. Assuming $500,000 of monthly salaries, the journal entry to
record the monthly contribution is shown below.
Dec. 31 Pension Expense 50,000

Cash 50,000
Contributed 10% of monthly salaries
to pension plan.
In a defined benefit plan, the company pays the employee a fixed annual pension
based on a formula. The formula is normally based on such factors as the employee’s
years of service, age, and past salary.
In a defined benefit plan, the employer is obligated to pay for (fund) the em-
ployee’s future pension benefits. As a result, many companies are replacing their
defined benefit plans with defined contribution plans.
The pension cost of a defined benefit plan is debited to Pension Expense. Cash is
credited for the amount contributed (funded) by the employer. Any unfunded amount
is credited to Unfunded Pension Liability.
To illustrate, assume that the defined benefit plan of Hinkle Co. requires an
annual pension cost of $80,000. This annual contribution is based on estimates
of Hinkle’s future pension liabilities. On December 31, Hinkle Co. pays $60,000 to
the pension fund. The entry to record the payment and the unfunded liability is
shown on the next page.
Dec. 31 Pension Expense 80,000

Cash 60,000
Unfunded Pension Liability 20,000
Annual pension cost and contribution.
If the unfunded pension liability is to be paid within one year, it is reported as a

current liability on the balance sheet. Any portion of the unfunded pension liability
that will be paid beyond one year is a long-term liability.
The accounting for pensions is complex due to the uncertainties of estimating
future pension liabilities. These estimates depend on such factors as employee life
expectancies, employee turnover, expected employee compensation levels, and invest-
ment income on pension contributions. Additional accounting and disclosures related
to pensions are covered in advanced accounting courses.
Example Exercise 11-6 Vacation Pay and Pension Benefits

Manfield Services Company provides its employees vacation benefits and a defined contribution pension plan. Employees
earned vacation pay of $44,000 for the period. The pension plan requires a contribution to the plan administrator equal to
8% of employee salaries. Salaries were $450,000 during the period.
Provide the journal entry for the (a) vacation pay and (b) pension benefit.
a. Vacation Pay Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44,000

Vacation Pay Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44,000
Vacation pay accrued for the period.
b. Pension Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36,000
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36,000
Pension contribution, 8% of $450,000 salary.
Postretirement Benefits Other than Pensions

Employees may earn rights to other postretirement benefits from their employer.
Such benefits may include dental care, eye care, medical care, life insurance, tuition
assistance, tax services, and legal services.
The accounting for other postretirement benefits is similar to that of defined benefit
pension plans. The estimate of the annual benefits expense is recorded by debiting
Postretirement Benefits Expense. If the benefits are fully funded, Cash is credited for
the same amount. If the benefits are not fully funded, a postretirement benefits plan
liability account is also credited.
The financial statements should disclose the nature of the postretirement benefit
liabilities. These disclosures are usually included as notes to the financial statements.
Additional accounting and disclosures for postretirement benefits are covered in ad-
vanced accounting courses.
Current Liabilities on the Balance Sheet

Accounts payable, the current portion of long-term debt, notes payable, and any
other debts that are due within one year are reported as current liabilities on the
balance sheet. The balance sheet presentation of current liabilities for Mornin’ Joe
is as shown on the next page.
Mornin’ Joe
Balance Sheet
December 31, 2014
Liabilities
Current liabilities:
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $133,000
Notes payable (current portion) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200,000
Salaries and wages payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42,000
Payroll taxes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16,400
Interest payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40,000
Total current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $431,400
Business Connection
GENERAL MOTORS’ PENSION PROBLEMS costs began to put a financial strain on the company. In
2003, the company issued $18.5 billion in debt to fund its
In June 2009, General Motors Company, the world’s growing unfunded pension liability, but this only provided
second-largest automaker, filed for bankruptcy. The com- a temporary fix. From 1993 to 2007, General Motors spent
pany’s troubles began decades earlier when the company $103 billion on pension and health care benefits for retir-
agreed to provide employees with large pension benefits ees, and the company had 4.61 retired union employees
instead of giving them wage increases. While this strategy for every one active union employee. By June 2009, the
was initially successful, by the mid-1990s large numbers combination of growing pension obligations and deterio-
of employees began to retire, and the increasing pension rating sales forced the company into bankruptcy.
Source: R. Lowenstein, “Siphoning GM’s Future,” The New York Times, July 10, 2008.
Contingent Liabilities Describe the

accounting
treatment for contingent
Some liabilities may arise from past transactions only if certain events occur in the
liabilities and journalize
future. These potential liabilities are called contingent liabilities.
entries for product
The accounting for contingent liabilities depends on the following two factors: warranties.
1. Likelihood of occurring: Probable, reasonably possible, or remote
2. Measurement: Estimable or not estimable
The likelihood that the event creating the liability occurring is classified as probable,
reasonably possible, or remote. The ability to estimate the potential liability is classi-
fied as estimable or not estimable.
Probable and Estimable

If a contingent liability is probable and the amount of the liability can be reason-
ably estimated, it is recorded and disclosed. The liability is recorded by debiting an
expense and crediting a liability.
To illustrate, assume that during June a company sold a product for $60,000
that includes a 36-month warranty for repairs. The average cost of repairs over the
warranty period is 5% of the sales price. The entry to record the estimated product
warranty expense for June is as shown below.
June 30 Product Warranty Expense 3,000

Product Warranty Payable 3,000
Warranty expense for June, 5% × $60,000.
The preceding entry records warranty expense in the same period in which the sale
is recorded. In this way, warranty expense is matched with the related revenue (sales).
If the product is repaired under warranty, the repair costs are recorded by debit-
The estimated costs of ing Product Warranty Payable and crediting Cash, Supplies, Wages Payable, or other
warranty work on new appropriate accounts. Thus, if a $200 part is replaced under warranty on August 16,
car sales are a contingent
the entry is as follows:
liability for Ford Motor
Company.
Aug. 16 Product Warranty Payable 200

Supplies 200
Replaced defective part under warranty.
Example Exercise 11-7 Estimated Warranty Liability

Cook-Rite Co. sold $140,000 of kitchen appliances during August under a six-month warranty. The cost to repair defects
under the warranty is estimated at 6% of the sales price. On September 11, a customer required a $200 part replacement
plus $90 of labor under the warranty.
Provide the journal entry for (a) the estimated warranty expense on August 31 for August sales, and (b) the September 11
warranty work.

a. Product Warranty Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,400
Product Warranty Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,400
To record warranty expense for August, 6% × $140,000.
b. Product Warranty Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 290
Supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200
Wages Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90
Replaced defective part under warranty.
Probable and Not Estimable

A contingent liability may be probable, but cannot be estimated. In this case, the contin-
gent liability is disclosed in the notes to the financial statements. For example, a company
may have accidentally polluted a local river by dumping waste products. At the end
of the period, the cost of the cleanup and any fines may not be able to be estimated.
Reasonably Possible
A contingent liability may be only possible. For example, a company may have lost a law-
suit for infringing on another company’s patent rights. However, the verdict is under appeal
and the company’s lawyers feel that the verdict will be reversed or significantly reduced.
In this case, the contingent liability is disclosed in the notes to the financial statements.
Remote
A contingent liability may be remote. For example, a ski resort may be sued for
injuries incurred by skiers. In most cases, the courts have found that a skier accepts
the risk of injury when participating in the activity. Thus, unless the ski resort is
grossly negligent, the resort will not incur a liability for ski injuries. In such cases, no
disclosure needs to be made in the notes to the financial statements. The accounting
treatment of contingent liabilities is summarized in Exhibit 8.
Common examples of contingent liabilities disclosed in notes to the financial
statements are litigation, environmental matters, guarantees, and contingencies from
the sale of receivables.
Exhibit 8 Accounting Treatment of Contingent Liabilities
Likelihood Accounting
of Occurring Measurement Treatment
Record and
Probable Estimable
Disclose Liability
Not Estimable Disclose Liability
Contingency Reasonably
Disclose Liability
Possible

Remote None
An example of a contingent liability disclosure from a recent annual report o

f
Google Inc. is shown below.
e have also had copyright claims filed against us alleging that features of certain of
W
our products and services, including Google Web Search, Google News, Google Video,
Google Image Search, Google Book Search and YouTube, infringe their rights. Adverse
results in these lawsuits may include awards of substantial monetary damages, costly
royalty or licensing agreements or orders preventing us from offering certain func-
tionalities, and may also result in a change in our business practices, which could
result in a loss of revenue for us or otherwise harm our business. . . .
Although the results of litigation and claims cannot be predicted with certainty,
we believe that the final outcome of the matters discussed above will not have a
material adverse effect on our business. . . .
Professional judgment is necessary in distinguishing between classes of contin-
gent liabilities. This is especially the case when distinguishing between probable and
reasonably possible contingent liabilities.
Financial Analysis and Interpretation:

Quick Ratio
Describe and
Current position analysis helps creditors evaluate a company’s ability to pay its cur- illustrate the
rent liabilities. This analysis is based on the following three measures: use of the quick ratio in
1. Working capital analyzing a company’s
ability to pay its current
2. Current ratio
liabilities.
3. Quick ratio
Working capital and the current ratio were discussed in Chapter 4 and are computed
as follows:
Working Capital = Current Assets – Current Liabilities
Current Assets
Current Ratio =
Current Liabilities
While these two measures can be used to evaluate a company’s ability to pay its
current liabilities, they do not provide insight into the company’s ability to pay these
liabilities within a short period of time. This is because some current assets, such as
inventory, cannot be converted into cash as quickly as other current assets, such as
cash and accounts receivable.
The quick ratio overcomes this limitation by measuring the “instant” debt-paying
ability of a company and is computed as follows:
Quick Assets
Quick Ratio =
Current Liabilities
Quick assets are cash and other current assets that can be easily converted to cash.
This normally includes cash, temporary investments, and accounts receivable. To
illustrate, consider the following data for TechSolutions, Inc., at the end of 2013:
Current assets:
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,020
Temporary investments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,400
Accounts receivable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,600
Inventory. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,000
Other current assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160
Total current assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $9,180
Accounts payable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $3,000
Other current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,400
Total current liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $5,400
Working capital (current assets – current liabilities). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $3,780

Current ratio (current assets/current liabilities). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.7
The quick ratio for TechSolutions, Inc., is computed as follows:

$2,020 + $3,400 + $1,600
Quick Ratio = = 1.3
$5,400
The quick ratio of 1.3 indicates that the company has more than enough quick assets to
pay its current liabilities in a short period of time. A quick ratio below 1.0 would indi-
cate that the company does not have enough quick assets to cover its current liabilities.
Like the current ratio, the quick ratio is particularly useful in making comparisons
across companies. To illustrate, the following selected balance sheet data (exclud-
ing ratios) were taken from recent financial statements of Panera Bread Company and
Starbucks Corporation (in thousands):
Panera Bread Starbucks
Current assets:
Cash and cash equivalents. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $229,299 $1,164,000
Temporary investments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 285,700
Accounts receivable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63,136 606,900
Inventory. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14,345 543,300
Other current assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23,905 156,500
Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $330,685 $2,756,400
Accounts payable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $211,516 $1,365,000
Other current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 414,000
Total current liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $211,516 $1,779,000
Working capital (current assets – current liabilities). . . . . . . . . . . . . . . . . . . . . $119,169 $ 977,400

Current ratio (current assets/current liabilities). . . . . . . . . . . . . . . . . . . . . . . . . 1.6 1.5
Quick ratio (quick assets/current liabilities)*. . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.4 1.2
*The quick ratio for each company is computed as follows:

Panera Bread: ($229,299 + $0 + $63,136) ÷ $211,516 = 1.4
Starbucks: ($1,164,000 + $285,700 + $606,900) ÷ $1,779,000 = 1.2
Starbucks is larger than Panera Bread and has over eight times the amount of
working capital. Such size differences make working capital comparisons between
companies difficult. In contrast, the current and quick ratios provide better com-
parisons across companies. In this example, Panera Bread has a slightly higher
current ratio than Starbucks. However, Starbucks’ 1.2 quick ratio reveals that it
has just enough quick assets to cover its current liabilities, while Panera Bread’s
quick ratio of 1.4 indicates that the company has more than enough quick assets
to meet its current liabilities.
Example Exercise 11-8 Quick Ratio

Sayer Company reported the following current assets and current liabilities for the years ended December 31,
2014 and 2013:
2014 2013
Cash $1,250 $1,000
Temporary investments 1,925 1,650
Accounts receivable 1,775 1,350
Inventory 1,900 1,700
Accounts payable 2,750 2,500
a. Compute the quick ratio for 2014 and 2013.

b. Interpret the company’s quick ratio across the two time periods.
a. December 31, 2014:

Quick Ratio = Quick Assets/Current Liabilities
Quick Ratio = ($1,250 + $1,925 + $1,775)/$2,750
Quick Ratio = 1.8
December 31, 2013:
Quick Ratio = Quick Assets/Current Liabilities
Quick Ratio = ($1,000 + $1,650 + $1,350)/$2,500
Quick Ratio = 1.6
b. The quick ratio of Sayer Company has improved from 1.6 in 2013 to 1.8 in 2014. This increase is the result of a large
increase in the three types of quick assets (cash, temporary investments, and accounts receivable) compared to a
relatively smaller increase in the current liability, accounts payable.
At a Glance 11
escribe and illustrate current liabilities related to accounts payable, current portion of long-term debt,
D
and notes payable.
Key Points Current liabilities are obligations that are to be paid out of current assets and are due within a
short time, usually within one year. The three primary types of current liabilities are accounts payable, notes
payable, and the current portion of long-term debt.
Learning Outcomes Example Practice

Exercises Exercises
• Identify and define the most frequently reported current
liabilities on the balance sheet.
• Determine the interest from interest-bearing and EE11-1 PE11-1A, 11-1B
discounted notes payable.
etermine employer liabilities for payroll, including liabilities arising from employee earnings and
D
deductions from earnings.
Key Points An employer’s liability for payroll is determined from employee total earnings, including over-
time pay. From this amount, employee deductions are subtracted to arrive at the net pay to be paid to each
employee. Most employers also incur liabilities for payroll taxes, such as social security tax, Medicare tax,
federal unemployment compensation tax, and state unemployment compensation tax.

Exercises Exercises
• Compute the federal withholding tax from a wage EE11-2 PE11-2A, 11-2B
bracket withholding table.
• Compute employee net pay, including deductions for EE11-3 PE11-3A, 11-3B
social security and Medicare tax.
escribe payroll accounting systems that use a payroll register, employee earnings records, and
D
a general journal.
Key Points The payroll register is used in assembling and summarizing the data needed for each payroll
period. The payroll register is supported by a detailed payroll record for each employee, called an employee’s
earnings record.

Exercises Exercises
• Journalize the employee’s earnings, net pay, and payroll EE11-4 PE11-4A, 11-4B
liabilities from the payroll register.
• Journalize the payroll tax expense. EE11-5 PE11-5A, 11-5B
• Describe elements of a payroll system, including the
employee’s earnings record, payroll checks, and internal
controls.
514
Journalize entries for employee fringe benefits, including vacation pay and pensions.
Key Points Fringe benefits are expenses of the period in which the employees earn the benefits. Fringe
benefits are recorded by debiting an expense account and crediting a liability account.

Exercises Exercises
• Journalize vacation pay. EE11-6 PE11-6A, 11-6B
• Distinguish and journalize defined contribution and EE11-6 PE11-6A, 11-6B
defined benefit pension plans.
Describe the accounting treatment for contingent liabilities and journalize entries for product warranties.
Key Points A contingent liability is a potential obligation that results from a past transaction but depends
on a future event. The accounting for contingent liabilities is summarized in Exhibit 8.

Exercises Exercises
• Describe the accounting for contingent liabilities.
• Journalize estimated warranty obligations and services EE11-7 PE11-7A, 11-7B
granted under warranty.
Describe and illustrate the use of the quick ratio in analyzing a company’s ability to pay its current liabilities.
Key Points The quick ratio is a measure of a company’s ability to pay current liabilities within a short pe-
riod of time. The quick ratio is computed by dividing quick assets by current liabilities. Quick assets include
cash, temporary investments, accounts receivable, and other current assets that can be easily converted into
cash. A quick ratio exceeding 1.0 is usually desirable.

Exercises Exercises
• Describe the quick ratio.
• Compute and evaluate the quick ratio. EE11-8 PE11-8A, 11-8B
Key Terms
contingent liabilities (509) FICA tax (498) payroll register (500)

current position analysis (511) fringe benefits (506) pension (507)
defined benefit plan (507) gross pay (496) quick assets (512)
defined contribution plan (507) net pay (496) quick ratio (512)
employee’s earnings record (502) payroll (495)
Illustrative Problem
Selected transactions of Taylor Company, completed during the fiscal year ended Decem-
ber 31, are as follows:
Mar. 1. Purchased merchandise on account from Kelvin Co., $20,000.

Apr. 10. Issued a 60-day, 12% note for $20,000 to Kelvin Co. on account.
June 9. Paid Kelvin Co. the amount owed on the note of April 10.
Aug. 1. Issued a $50,000, 90-day note to Harold Co. in exchange for a building. Harold
Co. discounted the note at 15%.
Oct. 30. Paid Harold Co. the amount due on the note of August 1.
Dec. 27. Journalized the entry to record the biweekly payroll. A summary of the payroll
record follows:
Salary distribution:
Sales $63,400
Officers 36,600
Office 10,000 $110,000
Deductions:
Social security tax $ 6,600
Medicare tax 1,650
Federal income tax withheld 17,600
State income tax withheld 4,950
Savings bond deductions 850
Medical insurance deductions 1,120 32,770
Net amount $ 77,230
27. Journalized the entry to record payroll taxes for social security and Medicare
from the biweekly payroll.
30. Issued a check in payment of liabilities for employees’ federal income tax of
$17,600, social security tax of $13,200, and Medicare tax of $3,300.
31. Issued a check for $9,500 to the pension fund trustee to fully fund the pension
cost for December.
31. Journalized an entry to record the employees’ accrued vacation pay, $36,100.
31. Journalized an entry to record the estimated accrued product warranty liability,
$37,240.
Instructions
Journalize the preceding transactions.
Solution
Mar. 1 Merchandise Inventory 20,000

Accounts Payable—Kelvin Co. 20,000
Apr. 10 Accounts Payable—Kelvin Co. 20,000

June 9 Notes Payable 20,000

Cash 20,400
Aug. 1 Building 48,125

Interest Expense 1,875
Oct. 30 Notes Payable 50,000

Cash 50,000
Dec. 27 Sales Salaries Expense 63,400

Ofﬁcers Salaries Expense 36,600
Ofﬁce Salaries Expense 10,000
Social Security Tax Payable 6,600
Medicare Tax Payable 1,650
Employees Federal Income Tax Payable 17,600
Employees State Income Tax Payable 4,950
Bond Deductions Payable 850
Medical Insurance Payable 1,120
Salaries Payable 77,230
27 Payroll Tax Expense 8,250

30 Employees Federal Income Tax Payable 17,600

Cash 34,100
31 Pension Expense 9,500

Cash 9,500
Fund pension cost.
31 Vacation Pay Expense 36,100

Vacation Pay Payable 36,100
Accrue vacation pay.
31 Product Warranty Expense 37,240

Product Warranty Payable 37,240
Accrue warranty expense.
Discussion Questions
1. Does a discounted note payable provide credit with- 5. What are the principal reasons for using a special
out interest? Discuss. payroll bank account?
2. Employees are subject to taxes withheld from their 6. In a payroll system, what types of input data are
paychecks. referred to as (a) constants and (b) variables?
a. List the federal taxes withheld from most em- 7. To match revenues and expenses properly, should
ployee paychecks. the expense for employee vacation pay be recorded
b. Give the title of the accounts credited by in the period during which the vacation privilege is
amounts withheld. earned or during the period in which the vacation
is taken? Discuss.
3. Why are deductions from employees’ earnings clas-
sified as liabilities for the employer? 8. Explain how a defined contribution pension plan
works.
4. For each of the following payroll-related taxes, indi-
cate whether they generally apply to (a) employees 9. When should the liability associated with a product
only, (b) employers only, or (c) both employees and warranty be recorded? Discuss.
employers:
10. General Motors Corporation reported $2.6 billion of
1. Federal income tax product warranties in the Current Liabilities sec-
2. Medicare tax tion of a recent balance sheet. How would costs of
3. Social security tax repairing a defective product be recorded?
4. Federal unemployment compensation tax
5. State unemployment compensation tax
Practice Exercises
Example
Exercises
EE 11-1 p. 495 PE 11-1A Proceeds from notes payable OBJ. 1
On October 12, Belleville Co. borrowed cash from Texas Bank by issuing a 30-day note
with a face amount of $70,000.
EE 11-1 p. 495 PE 11-1B Proceeds from notes payable OBJ. 1

On January 26, Nyree Co. borrowed cash from Conrad Bank by issuing a 45-day note
with a face amount of $150,000.
EE 11-2 p. 497 PE 11-2A Federal income tax withholding OBJ. 2

Bella Chen’s weekly gross earnings for the present week were $2,600. Chen has two
exemptions. Using the wage bracket withholding table in Exhibit 3 with a $70 standard
withholding allowance for each exemption, what is Chen’s federal income tax withholding?
Example
Exercises
EE 11-2 p. 497 PE 11-2B Federal income tax withholding OBJ. 2
Todd Thompson’s weekly gross earnings for the present week were $1,400. Thompson
has one exemption. Using the wage bracket withholding table in Exhibit 3 with a $70
standard withholding allowance for each exemption, what is Thompson’s federal income
tax withholding?
EE 11-3 p. 499 PE 11-3A Employee net pay OBJ. 2

Bella Chen’s weekly gross earnings for the week ended October 20 were $2,600, and her
federal income tax withholding was $554.76. Assuming the social security rate is 6% and
Medicare is 1.5% of all earnings, what is Chen’s net pay?
EE 11-3 p. 499 PE 11-3B Employee net pay OBJ. 2

Todd Thompson’s weekly gross earnings for the week ended May 23 were $1,400, and
his federal income tax withholding was $247.90. Assuming the social security rate is 6%
and Medicare is 1.5% of all earnings, what is Thompson’s net pay?
EE 11-4 p. 501 PE 11-4A Journalize period payroll OBJ. 3

The payroll register of Konrath Co. indicates $13,200 of social security withheld and $3,300
of Medicare tax withheld on total salaries of $220,000 for the period. Federal withholding
for the period totaled $43,560.
EE 11-4 p. 501 PE 11-4B Journalize period payroll OBJ. 3

The payroll register of Longboat Co. indicates $5,400 of social security withheld and $1,350
of Medicare tax withheld on total salaries of $90,000 for the period. Retirement savings
withheld from employee paychecks were $5,400 for the period. Federal withholding for
the period totaled $17,820.
EE 11-5 p. 502 PE 11-5A Journalize payroll tax OBJ. 3

The payroll register of Konrath Co. indicates $13,200 of social security withheld and
$3,300 of Medicare tax withheld on total salaries of $220,000 for the period. Earnings of
$35,000 are subject to state and federal unemployment compensation taxes at the federal
rate of 0.8% and the state rate of 5.4%.
EE 11-5 p. 502 PE 11-5B Journalize payroll tax OBJ. 3

The payroll register of Longboat Co. indicates $5,400 of social security withheld and
$1,350 of Medicare tax withheld on total salaries of $90,000 for the period. Earnings of
$10,000 are subject to state and federal unemployment compensation taxes at the federal
rate of 0.8% and the state rate of 5.4%.
EE 11-6 p. 508 PE 11-6A Vacation pay and pension benefits OBJ. 4

Fukushima Company provides its employees with vacation benefits and a defined con-
tribution pension plan. Employees earned vacation pay of $19,500 for the period. The
pension plan requires a contribution to the plan administrator equal to 6% of employee
salaries. Salaries were $260,000 during the period.
Example
Exercises
EE 11-6 p. 508 PE 11-6B Vacation pay and pension benefits OBJ. 4
Regling Company provides its employees vacation benefits and a defined benefit pension
plan. Employees earned vacation pay of $35,000 for the period. The pension formula
calculated a pension cost of $201,250. Only $175,000 was contributed to the pension
plan administrator.
EE 11-7 p. 510 PE 11-7A Estimated warranty liability OBJ. 5

Kyrgyz Co. sold $200,000 of equipment during February under a one-year warranty. The
cost to repair defects under the warranty is estimated at 6% of the sales price. On July
24, a customer required a $60 part replacement, plus $32 of labor under the warranty.
Provide the journal entry for (a) the estimated warranty expense on February 28 for
February sales, and (b) the July 24 warranty work.
EE 11-7 p. 510 PE 11-7B Estimated warranty liability OBJ. 5

Quantas Industries sold $325,000 of consumer electronics during July under a nine-month
warranty. The cost to repair defects under the warranty is estimated at 4.5% of the sales
price. On November 11, a customer was given $220 cash under terms of the warranty.
Provide the journal entry for (a) the estimated warranty expense on July 31 for July
sales, and (b) the November 11 cash payment.
EE 11-8 p. 513 PE 11-8A Quick ratio OBJ. 6

Nabors Company reported the following current assets and liabilities for December 31,
2014 and 2013:
Dec. 31, 2014 Dec. 31, 2013
Cash $ 650 $ 680
Accounts receivable 700 770
a. Compute the quick ratio for December 31, 2014 and 2013.
b. Interpret the company’s quick ratio. Is the quick ratio improving or declining?
EE 11-8 p. 513 PE 11-8B Quick ratio OBJ. 6

Adieu Company reported the following current assets and liabilities for December 31,
2014 and 2013:
Dec. 31, 2014 Dec. 31, 2013
Cash $1,000 $1,140
Accounts receivable 800 910
a. Compute the quick ratio for December 31, 2014 and 2013.
b. Interpret the company’s quick ratio. Is the quick ratio improving or declining?
Exercises
EX 11-1 Current liabilities OBJ. 1
Total current Bon Nebo Co. sold 25,000 annual subscriptions of Bjorn 20XX for $85 during December
liabilities, $1,929,750 2014. These new subscribers will receive monthly issues, beginning in January 2015. In
addition, the business had taxable income of $840,000 during the first calendar quarter of
2015. The federal tax rate is 40%. A quarterly tax payment will be made on April 12, 2015.
Prepare the Current Liabilities section of the balance sheet for Bon Nebo Co. on
March 31, 2015.
EX 11-2 Entries for discounting notes payable OBJ. 1

Swain Enterprises issues a 60-day note for $800,000 to Hill Industries for merchandise
inventory. Hill Industries discounts the note at 6%.
a. Journalize Swain Enterprises’ entries to record:
1. the issuance of the note.
2. the payment of the note at maturity.
b. Journalize Hill Industries’ entries to record:
1. the receipt of the note.
2. the receipt of the payment of the note at maturity.
EX 11-3 Evaluating alternative notes OBJ. 1

A borrower has two alternatives for a loan: (1) issue a $240,000, 60-day, 8% note or
(2) issue a $240,000, 60-day note that the creditor discounts at 8%.
a. Calculate the amount of the interest expense for each option.
b. Determine the proceeds received by the borrower in each situation.
c. Which alternative is more favorable to the borrower? Explain.
EX 11-4 Entries for notes payable OBJ. 1

A business issued a 30-day, 7% note for $150,000 to a creditor on account. Journalize
the entries to record (a) the issuance of the note and (b) the payment of the note at
maturity, including interest.
EX 11-5 Entries for discounted note payable OBJ. 1

A business issued a 45-day note for $90,000 to a creditor on account. The note was dis-
counted at 8%. Journalize the entries to record (a) the issuance of the note and (b) the
payment of the note at maturity.
EX 11-6 Fixed asset purchases with note OBJ. 1

On June 30, Techcram Management Company purchased land for $350,000 and a building for
$450,000, paying $400,000 cash and issuing a 6% note for the balance, secured by a mortgage
on the property. The terms of the note provide for 20 semiannual payments of $20,000 on
the principal plus the interest accrued from the date of the preceding payment. Journalize
the entry to record (a) the transaction on June 30, (b) the payment of the first installment on
December 31, and (c) the payment of the second installment the following June 30.
EX 11-7 Current portion of long-term debt OBJ. 1

The Coca-Cola Company reported the following information about its long-term debt in the
notes to a recent financial statement (in millions):
Long-term debt is comprised of the following:
December 31
Current Year preceding Year
Total long term-debt $15,317 $5,110
Less current portion (1,276) (51)
Long-term debt $14,041 $5,059
a. How much of the long-term debt was disclosed as a current liability on the current
year’s December 31 balance sheet?
b. How much did the total current liabilities change between the preceding year and the
current year as a result of the current portion of long-term debt?
c. If Coca-Cola did not issue additional long-term debt next year, what would be the
total long-term debt on December 31 of the upcoming year?
EX 11-8 Calculate payroll OBJ. 2

b. Net pay, An employee earns $50 per hour and 2 times that rate for all hours in excess of 40 hours
$2,089 per week. Assume that the employee worked 50 hours during the week. Assume further
that the social security tax rate was 6.0%, the Medicare tax rate was 1.5%, and federal
income tax to be withheld was $686.
a. Determine the gross pay for the week.
b. Determine the net pay for the week.
EX 11-9 Calculate payroll OBJ. 2

Administrator net Snyder Company has three employees—a consultant, a computer programmer, and an
pay, $1,856.44 administrator. The following payroll information is available for each employee:
Consultant Computer Programmer Administrator
Regular earnings rate $3,800 per week $40 per hour $44 per hour
Overtime earnings rate* Not applicable 1.5 times hourly rate 2 times hourly rate
Number of withholding allowances 2 2 1
* For hourly employees, overtime is paid for hours worked in excess of 40 hours per week.
For the current pay period, the computer programmer worked 60 hours and the ad-
ministrator worked 50 hours. The federal income tax withheld for all three employees,
who are single, can be determined from the wage bracket withholding table in Exhibit 3
in the chapter. Assume further that the social security tax rate was 6.0%, the Medicare
tax rate was 1.5%, and one withholding allowance is $70.
Determine the gross pay and the net pay for each of the three employees for the
current pay period.
EX 11-10 Summary payroll data OBJ. 2, 3

a. (3) Total In the following summary of data for a payroll period, some amounts have been inten-
earnings, $540,000 tionally omitted:
Earnings:
1. At regular rate ?
2. At overtime rate $80,000
3. Total earnings ?
Deductions:
4. Social security tax 32,400
5. Medicare tax 8,100
6. Income tax withheld 135,000
7. Medical insurance 18,900
8. Union dues ?
9. Total deductions 201,150
10. Net amount paid 338,850
Accounts debited:
11. Factory Wages 285,000
12. Sales Salaries ?
13. Office Salaries 120,000
a. Calculate the amounts omitted in lines (1), (3), (8), and (12).
b. Journalize the entry to record the payroll accrual.
c. Journalize the entry to record the payment of the payroll.
EX 11-11 Payroll tax entries OBJ. 3

a. $68,480 According to a summary of the payroll of Bailik Co., $880,000 was subject to the 6.0%
social security tax and the 1.5% Medicare tax. Also, $40,000 was subject to state and
federal unemployment taxes.
a. Calculate the employer’s payroll taxes, using the following rates: state unemployment,
5.4%; federal unemployment, 0.8%.
b. Journalize the entry to record the accrual of payroll taxes.
EX 11-12 Payroll entries OBJ. 3

The payroll register for Jaffrey Company for the week ended May 16 indicated the fol-
lowing:
Salaries $1,250,000
Social security tax withheld 58,750
Medicare tax withheld 18,750
In addition, state and federal unemployment taxes were calculated at the rate of 5.4%
and 0.8%, respectively, on $225,000 of salaries.
a. Journalize the entry to record the payroll for the week of May 16.
b. Journalize the entry to record the payroll tax expense incurred for the week of
May 16.
EX 11-13 Payroll entries OBJ. 3

Widmer Company had gross wages of $240,000 during the week ended June 17. The
amount of wages subject to social security tax was $240,000, while the amount of wages
subject to federal and state unemployment taxes was $35,000. Tax rates are as follows:
Social security 6.0%

Medicare 1.5%
State unemployment 5.4%
Federal unemployment 0.8%
The total amount withheld from employee wages for federal taxes was $48,000.
a. Journalize the entry to record the payroll for the week of June 17.
b. Journalize the entry to record the payroll tax expense incurred for the week of
June 17.
EX 11-14 Payroll internal control procedures OBJ. 3

Big Howie’s Hot Dog Stand is a fast-food restaurant specializing in hot dogs and hamburg-
ers. The store employs 8 full-time and 12 part-time workers. The store’s weekly payroll
averages $5,600 for all 20 workers.
Big Howie’s Hot Dog Stand uses a personal computer to assist in preparing paychecks.
Each week, the store’s accountant collects employee time cards and enters the hours
worked into the payroll program. The payroll program calculates each employee’s pay and
prints a paycheck. The accountant uses a check-signing machine to sign the paychecks.
Next, the restaurant’s owner authorizes the transfer of funds from the restaurant’s regular
bank account to the payroll account.
For the week of May 12, the accountant accidentally recorded 100 hours worked
instead of 40 hours for one of the full-time employees.
Does Big Howie’s Hot Dog Stand have internal controls in place to catch this
error? If so, how will this error be detected?
EX 11-15 Internal control procedures OBJ. 3

Dave’s Scooters is a small manufacturer of specialty scooters. The company employs 14
production workers and four administrative persons. The following procedures are used
to process the company’s weekly payroll:
a. Whenever an employee receives a pay raise, the supervisor must fill out a wage adjust-
ment form, which is signed by the company president. This form is used to change
the employee’s wage rate in the payroll system.
b. All employees are required to record their hours worked by clocking in and out on a
time clock. Employees must clock out for lunch break. Due to congestion around the
time clock area at lunch time, management has not objected to having one employee
clock in and out for an entire department.
(continued)
c. Whenever a salaried employee is terminated, Personnel authorizes Payroll to remove

the employee from the payroll system. However, this procedure is not required when
an hourly worker is terminated. Hourly employees only receive a paycheck if their time
cards show hours worked. The computer automatically drops an employee from the
payroll system when that employee has six consecutive weeks with no hours worked.
d. Paychecks are signed by using a check-signing machine. This machine is located in
the main office so that it can be easily accessed by anyone needing a check signed.
e. Dave’s Scooters maintains a separate checking account for payroll checks. Each week,
the total net pay for all employees is transferred from the company’s regular bank
account to the payroll account.
State whether each of the procedures is appropriate or inappropriate, after
considering the principles of internal control. If a procedure is inappropriate, describe
the appropriate procedure.
EX 11-16 Accrued vacation pay OBJ. 4

A business provides its employees with varying amounts of vacation per year, depend-
ing on the length of employment. The estimated amount of the current year’s vacation
pay is $42,000.
a. Journalize the adjusting entry required on January 31, the end of the first month of
the current year, to record the accrued vacation pay.
b. How is the vacation pay reported on the company’s balance sheet? When is this amount
removed from the company’s balance sheet?
EX 11-17 Pension plan entries OBJ. 4

Yuri Co. operates a chain of gift shops. The company maintains a defined contribution
pension plan for its employees. The plan requires quarterly installments to be paid to the
funding agent, Whims Funds, by the fifteenth of the month following the end of each
quarter. Assume that the pension cost is $365,000 for the quarter ended December 31.
a. Journalize the entries to record the accrued pension liability on December 31 and the
payment to the funding agent on January 15.
b. How does a defined contribution plan differ from a defined benefit plan?
EX 11-18 Defined benefit pension plan terms OBJ. 4

In a recent year’s financial statements, Procter & Gamble showed an unfunded pension li-
ability of $4,267 million and a periodic pension cost of $538 million.
Explain the meaning of the $4,267 million unfunded pension liability and the $538
million periodic pension cost.
EX 11-19 Accrued product warranty OBJ. 5

Lowe Manufacturing Co. warrants its products for one year. The estimated product war-
ranty is 4% of sales. Assume that sales were $560,000 for June. In July, a customer received
warranty repairs requiring $140 of parts and $95 of labor.
a. Journalize the adjusting entry required at June 30, the end of the first month of the
current fiscal year, to record the accrued product warranty.
b. Journalize the entry to record the warranty work provided in July.
EX 11-20 Accrued product warranty OBJ. 5

General Motors Corporation (GM) disclosed estimated product warranty payable for compara-
tive years as follows:
(in millions)
Year 2 Year 1
Current estimated product warranty payable $2,587 $2,965
Noncurrent estimated product warranty payable 4,202 4,065
Total $6,789 $7,030
GM’s sales were $135,592 million in Year 2. A ssume that the total paid on warranty claims
during Year 2 was $3,000 million.
a. Why are short- and long-term estimated warranty liabilities separately disclosed?
b. Provide the journal entry for the Year 2 product warranty expense.
c. What two conditions must be met in order for a product warranty liability to be re-
ported in the financial statements?
EX 11-21 Contingent liabilities OBJ. 5

Several months ago, Ayers Industries Inc. experienced a hazardous materials spill at one
of its plants. As a result, the Environmental Protection Agency (EPA) fined the company
$240,000. The company is contesting the fine. In addition, an employee is seeking $220,000
in damages related to the spill. Lastly, a homeowner has sued the company for $310,000.
The homeowner lives 35 miles from the plant, but believes that the incident has reduced
the home’s resale value by $310,000.
Ayers’ legal counsel believes that it is probable that the EPA fine will stand. In ad-
dition, counsel indicates that an out-of-court settlement of $125,000 has recently been
reached with the employee. The final papers will be signed next week. Counsel believes
that the homeowner’s case is much weaker and will be decided in favor of Ayers. Other
litigation related to the spill is possible, but the damage amounts are uncertain.
a. Journalize the contingent liabilities associated with the hazardous materials spill. Use
the account “Damage Awards and Fines” to recognize the expense for the period.
b. Prepare a note disclosure relating to this incident.
EX 11-22 Quick ratio OBJ. 6

a. 2014: 1.2 Gmeiner Co. had the following current assets and liabilities for two comparative years:
Dec. 31, 2014 Dec. 31, 2013
Current assets:
Cash $ 486,000 $ 500,000
Inventory 375,000 350,000
Total current assets $1,071,000 $1,050,000
Current portion of long-term debt $ 145,000 $ 110,000
Accrued and other current liabilities 260,000 240,000
Total current liabilities $ 580,000 $ 500,000
a. Determine the quick ratio for December 31, 2014 and 2013.
b. Interpret the change in the quick ratio between the two balance sheet dates.
EX 11-23 Quick ratio OBJ. 6

a. Apple, 1.8 The current assets and current liabilities for Apple Inc. and Dell, Inc., are shown as follows
at the end of a recent fiscal period:
Apple Inc. Dell, Inc.
(in millions) (in millions)
Current assets:
Cash and cash equivalents $11,261 $13,913
Short-term investments 14,359 452
Inventories 1,051 1,301
Other current assets* 3,447 3,219
Total current assets $41,678 $29,021
Accounts payable $17,738 $15,474
Accrued and other current liabilities 2,984 4,009
Total current liabilities $20,722 $19,483
*These represent prepaid expense and other nonquick current assets.
(continued)
a. Determine the quick ratio for both companies.

b. Interpret the quick ratio difference between the two companies.
Problems Series A
PR 11-1A Liability transactions OBJ. 1, 5

The following items were selected from among the transactions completed by Warwick
Co. during the current year:
Feb. 3. Purchased merchandise on account from Onifade Co., $410,000, terms n/30.
Mar. 3. Issued a 45-day, 6% note for $410,000 to Onifade Co., on account.
Apr. 17. Paid Onifade Co. the amount owed on the note of March 3.
June 1. Borrowed $250,000 from Aldhiezer Bank, issuing a 60-day, 7.5% note.
July 21. Purchased tools by issuing a $300,000, 60-day note to Nash Co., which
discounted the note at the rate of 8%.
31. Paid Aldhiezer Bank the interest due on the note of June 1 and renewed the
loan by issuing a new 30-day, 9% note for $250,000. ( Journalize both the debit
and credit to the notes payable account.)
Aug. 30. Paid Aldhiezer Bank the amount due on the note of July 31.
Sept. 19. Paid Nash Co. the amount due on the note of July 21.
Dec. 1. Purchased office equipment from Oso Co. for $340,000, paying $40,000 and issu-
ing a series of ten 8% notes for $30,000 each, coming due at 30-day intervals.
12. Settled a product liability lawsuit with a customer for $165,000, payable in Janu-
ary. Warwick accrued the loss in a litigation claims payable account.
31. Paid the amount due Oso Co. on the first note in the series issued on
December 1.
Instructions
1. Journalize the transactions.
2. Journalize the adjusting entry for each of the following accrued expenses at the end of
the current year:
a. Product warranty cost, $32,500.
b. Interest on the nine remaining notes owed to Oso Co.
PR 11-2A Entries for payroll and payroll taxes OBJ. 2, 3

1. (b) Dr. Payroll The following information about the payroll for the week ended December 30 was ob-
Tax Expense, $52,795 tained from the records of Qualitech Co.:
Salaries: Deductions:
Sales salaries $350,000 Income tax withheld $118,800
Warehouse salaries 180,000 Social security tax withheld 40,500
Office salaries 145,000 Medicare tax withheld 10,125
$675,000 U.S. savings bonds 14,850
Group insurance 12,150
$196,425
Tax rates assumed:

Social security, 6%
Medicare, 1.5%
State unemployment (employer only), 5.4%
Federal unemployment (employer only), 0.8%
Instructions
1. Assuming that the payroll for the last week of the year is to be paid on December
31, journalize the following entries:
a. December 30, to record the payroll.
b. December 30, to record the employer’s payroll taxes on the payroll to be paid on
December 31. Of the total payroll for the last week of the year, $35,000 is subject
to unemployment compensation taxes.
2. Assuming that the payroll for the last week of the year is to be paid on January 5 of
the following fiscal year, journalize the following entries:
b. January 5, to record the employer’s payroll taxes on the payroll to be paid on Janu-
ary 5. Since it is a new fiscal year, all $675,000 in salaries is subject to unemploy-
ment compensation taxes.
PR 11-3A Wage and tax statement data on employer FICA tax OBJ. 2, 3
2. (e) $28,574.96 Ehrlich Co. began business on January 2, 2013. Salaries were paid to employees on
the last day of each month, and social security tax, Medicare tax, and federal income
tax were withheld in the required amounts. An employee who is hired in the middle
of the month receives half the monthly salary for that month. All required payroll
tax reports were filed, and the correct amount of payroll taxes was remitted by the
company for the calendar year. Early in 2014, before the Wage and Tax Statements
(Form W-2) could be prepared for distribution to employees and for filing with the
Social Security Administration, the employees’ earnings records were inadvertently
destroyed.
None of the employees resigned or were discharged during the year, and there were
no changes in salary rates. The social security tax was withheld at the rate of 6.0% and
Medicare tax at the rate of 1.5%. Data on dates of employment, salary rates, and em-
ployees’ income taxes withheld, which are summarized as follows, were obtained from
personnel records and payroll records:
Monthly
Date First Monthly Income Tax
Employee Employed Salary Withheld
Arnett Nov. 16 $ 5,500 $1,008
Cruz Jan. 2 4,800 833
Edwards Oct. 1 8,000 1,659
Harvin Dec. 1 6,000 1,133
Nicks Feb. 1 10,000 2,219
Shiancoe Mar. 1 11,600 2,667
Ward Nov. 16 5,220 938
Instructions
1. Calculate the amounts to be reported on each employee’s Wage and Tax Statement
(Form W-2) for 2013, arranging the data in the following form:
Gross Federal Income Social Security Medicare

Employee Earnings Tax Withheld Tax Withheld Tax Withheld
2. Calculate the following employer payroll taxes for the year: (a) social security;
(b) Medicare; (c) state unemployment compensation at 5.4% on the first $10,000 of
each employee’s earnings; (d) federal unemployment compensation at 0.8% on the
first $10,000 of each employee’s earnings; (e) total.
PR 11-4A Payroll register OBJ. 2, 3

1. Total net pay The following data for Throwback Industries Inc. relate to the payroll for the week ended
$15,522.48 December 7, 2014:
Hours Hourly Weekly Federal U.S. Savings
Employee Worked Rate Salary Income Tax Bonds
Aaron 46 $68.00 $766.36 $100
Cobb 41 62.00 553.20 110
Clemente 48 70.00 691.60 120
DiMaggio 35 56.00 411.60 0
Griffey, Jr. 45 62.00 618.45 130
Mantle $1,800 432.00 120
Robinson 36 54.00 291.60 130
Williams 2,000 440.00 125
Vaughn 42 62.00 533.20 50
Employees Mantle and Williams are office staff, and all of the other employees are sales
personnel. All sales personnel are paid 1½ times the regular rate for all hours in excess
of 40 hours per week. The social security tax rate is 6.0%, and Medicare tax is 1.5% of
each employee’s annual earnings. The next payroll check to be used is No. 901.
Instructions
1. Prepare a payroll register for Throwback Industries Inc. for the week ended December
7, 2014. Use the following columns for the payroll register: Employee, Total Hours,
Regular Earnings, Overtime Earnings, Total Earnings, Social Security Tax, Medicare
Tax, Federal Income Tax, U.S. Savings Bonds, Total Deductions, Net Pay, Ck. No.,
Sales Salaries Expense, and Office Salaries Expense.
2. Journalize the entry to record the payroll for the week.
PR 11-5A Payroll accounts and year-end entries OBJ. 2, 3, 4

The following accounts, with the balances indicated, appear in the ledger of Garcon Co.
on December 1 of the current year:
211 Salaries Payable — 218 Bond Deductions Payable $ 3,400

212 Social Security Tax Payable $ 9,273 219 Medical Insurance Payable 27,000
213 Medicare Tax Payable 2,318 411 Operations Salaries Expense 950,000
214 Employees Federal Income Tax Payable 15,455 511 Officers Salaries Expense 600,000
215 Employees State Income Tax Payable 13,909 512 Office Salaries Expense 150,000
216 State Unemployment Tax Payable 1,400 519 Payroll Tax Expense 137,951
217 Federal Unemployment Tax Payable 500
The following transactions relating to payroll, payroll deductions, and payroll taxes
occurred during December:
Dec. 2. Issued Check No. 410 for $3,400 to Jay Bank to purchase U.S. savings bonds for
employees.
2. Issued Check No. 411 to Jay Bank for $27,046 in payment of $9,273 of social secu-
rity tax, $2,318 of Medicare tax, and $15,455 of employees’ federal income tax due.
13. Journalized the entry to record the biweekly payroll. A summary of the payroll
record follows:
Operations $43,200
Officers 27,200
Office 6,800 $77,200
Deductions:
Medicare tax 1,158
Savings bond deductions 1,700
Medical insurance deductions 4,500 30,904
Net amount $46,296
Dec. 13. Issued Check No. 420 in payment of the net amount of the biweekly payroll.
13. Journalized the entry to record payroll taxes on employees’ earnings of December
13: social security tax, $4,632; Medicare tax, $1,158; state unemployment tax,
$350; federal unemployment tax, $125.
16. Issued Check No. 424 to Jay Bank for $27,020, in payment of $9,264 of social secu-
rity tax, $2,316 of Medicare tax, and $15,440 of employees’ federal income tax due.
19. Issued Check No. 429 to Sims-Walker Insurance Company for $31,500 in payment
of the semiannual premium on the group medical insurance policy.
record follows:
Operations $42,800
Officers 28,000
Office 7,000 $77,800
Deductions:
Medicare tax 1,167
Savings bond deductions 1,700 26,440
Net amount $51,360
27. Issued Check No. 541 in payment of the net amount of the biweekly payroll.
27. Journalized the entry to record payroll taxes on employees’ earnings of Decem-
ber 27: social security tax, $4,668; Medicare tax, $1,167; state unemployment tax,
27. Issued Check No. 543 for $20,884 to State Department of Revenue in payment of
employees’ state income tax due on December 31.
31. Issued Check No. 545 to Jay Bank for $3,400 to purchase U.S. savings bonds for
employees.
31. Paid $45,000 to the employee pension plan. The annual pension cost is $60,000.
(Record both the payment and unfunded pension liability.)
Instructions
2. Journalize the following adjusting entries on December 31:
a. Salaries accrued: operations salaries, $8,560; officers salaries, $5,600; office salaries,
$1,400. The payroll taxes are immaterial and are not accrued.
b. Vacation pay, $15,000.
Problems Series B
PR 11-1B Liability transactions OBJ. 1, 5

The following items were selected from among the transactions completed by Aston Martin
Inc. during the current year:
Apr. 15. Borrowed $225,000 from Audi Company, issuing a 30-day, 6% note for that
amount.
May 1. Purchased equipment by issuing a $320,000, 180-day note to Spyder Manufactur-
ing Co., which discounted the note at the rate of 6%.
15. Paid Audi Company the interest due on the note of April 15 and renewed the
loan by issuing a new 60-day, 8% note for $225,000. (Record both the debit and
credit to the notes payable account.)
July 14. Paid Audi Company the amount due on the note of May 15.
Aug. 16. Purchased merchandise on account from Exige Co., $90,000, terms, n/30.
Sept. 15. Issued a 45-day, 6% note for $90,000 to Exige Co., on account.
Oct. 28. Paid Spyder Manufacturing Co. the amount due on the note of May 1.
30. Paid Exige Co. the amount owed on the note of September 15.
Nov. 16. Purchased store equipment from Gallardo Co. for $450,000, paying $50,000
and issuing a series of twenty 9% notes for $20,000 each, coming due at 30-day
intervals.
Dec. 16. Paid the amount due Gallardo Co. on the first note in the series issued on No-
vember 16.
28. Settled a personal injury lawsuit with a customer for $87,500, to be paid in Janu-
ary. Aston Martin Inc. accrued the loss in a litigation claims payable account.
Instructions
2. Journalize the adjusting entry for each of the following accrued expenses at the end
of the current year:
a. Product warranty cost, $26,800.
b. Interest on the 19 remaining notes owed to Gallardo Co.
PR 11-2B Entries for payroll and payroll taxes OBJ. 2, 3

1. (b) Dr. Payroll The following information about the payroll for the week ended December 30 was ob-
Tax Expense, $90,735 tained from the records of Saine Co.:
Salaries: Deductions:
Sales salaries $ 625,000 Income tax withheld $232,260
Warehouse salaries 240,000 Social security tax withheld 71,100
Office salaries 320,000 Medicare tax withheld 17,775
$1,185,000 U.S. savings bonds 35,500
Group insurance 53,325
$409,960
Tax rates assumed:
Social security, 6%
Medicare, 1.5%
State unemployment (employer only), 5.4%
Federal unemployment (employer only), 0.8%
Instructions
1. Assuming that the payroll for the last week of the year is to be paid on December
31, journalize the following entries:
b. December 30, to record the employer’s payroll taxes on the payroll to be paid on
December 31. Of the total payroll for the last week of the year, $30,000 is subject
to unemployment compensation taxes.
2. Assuming that the payroll for the last week of the year is to be paid on January 4 of
the following fiscal year, journalize the following entries:
b. January 4, to record the employer’s payroll taxes on the payroll to be paid on Janu-
ary 4. Since it is a new fiscal year, all $1,185,000 in salaries is subject to unemploy-
ment compensation taxes.
PR 11-3B Wage and tax statement data and employer FICA tax OBJ. 2, 3
2. (e) $25,136.13 Jocame Inc. began business on January 2, 2013. Salaries were paid to employees on
the last day of each month, and social security tax, Medicare tax, and federal income
tax were withheld in the required amounts. An employee who is hired in the middle
of the month receives half the monthly salary for that month. All required payroll
tax reports were filed, and the correct amount of payroll taxes was remitted by the
company for the calendar year. Early in 2014, before the Wage and Tax Statements
(Form W-2) could be prepared for distribution to employees and for filing with the
Social Security Administration, the employees’ earnings records were inadvertently
destroyed.
None of the employees resigned or were discharged during the year, and there were
no changes in salary rates. The social security tax was withheld at the rate of 6.0% and
Medicare tax at the rate of 1.5% on salary. Data on dates of employment, salary rates,
and employees’ income taxes withheld, which are summarized as follows, were obtained
from personnel records and payroll records:
Monthly
Date First Monthly Income Tax
Employee Employed Salary Withheld
Addai July 16 $ 8,160 $1,704
Kasay June 1 3,600 533
McGahee Feb. 16 6,420 1,238
Moss Jan. 1 4,600 783
Stewart Dec. 1 4,500 758
Tolbert Nov. 16 3,250 446
Wells May 1 10,500 2,359
Instructions
1. Calculate the amounts to be reported on each employee’s Wage and Tax Statement
(Form W-2) for 2013, arranging the data in the following form:
Gross Federal Income Social Security Medicare

Employee Earnings Tax Withheld Tax Withheld Tax Withheld
2. Calculate the following employer payroll taxes for the year: (a) social security;
(b) Medicare; (c) state unemployment compensation at 5.4% on the first $10,000 of
each employee’s earnings; (d) federal unemployment compensation at 0.8% on the
first $10,000 of each employee’s earnings; (e) total.
PR 11-4B Payroll register OBJ. 2, 3

1. Total net pay, The following data for Flexco Inc. relate to the payroll for the week ended December
$16,592.58 7, 2014:
Hours Hourly Weekly Federal U.S. Savings

Employee Worked Rate Salary Income Tax Bonds
Carlton 52 $50.00 $667.00 $ 60
Grove $4,000 860.00 100
Johnson 36 52.00 355.68 0
Koufax 45 58.00 578.55 44
Maddux 37 45.00 349.65 62
Seaver 3,200 768.00 120
Spahn 46 52.00 382.20 0
Winn 48 50.00 572.00 75
Young 43 54.00 480.60 80
Employees Grove and Seaver are office staff, and all of the other employees are sales
personnel. All sales personnel are paid 1½ times the regular rate for all hours in excess
of 40 hours per week. The social security tax rate is 6.0% of each employee’s annual
earnings, and Medicare tax is 1.5% of each employee’s annual earnings. The next payroll
check to be used is No. 328.
Instructions
1. Prepare a payroll register for Flexco Inc. for the week ended December 7, 2014. Use
the following columns for the payroll register: Employee, Total Hours, Regular Earn-
ings, Overtime Earnings, Total Earnings, Social Security Tax, Medicare Tax, Federal
Income Tax, U.S. Savings Bonds, Total Deductions, Net Pay, Ck. No., Sales Salaries
Expense, and Office Salaries Expense.
2. Journalize the entry to record the payroll for the week.
PR 11-5B Payroll accounts and year-end entries OBJ. 2, 3, 4

The following accounts, with the balances indicated, appear in the ledger of Codigo Co.
on December 1 of the current year:
101 Salaries Payable — 108 Bond Deductions Payable $ 2,300
102 Social Security Tax Payable $2,913 109 Medical Insurance Payable 2,520
103 Medicare Tax Payable 728 201 Sales Salaries Expense 700,000
104 Employees Federal Income Tax Payable 4,490 301 Officers Salaries Expense 340,000
105 Employees State Income Tax Payable 4,078 401 Office Salaries Expense 125,000
106 State Unemployment Tax Payable 1,260 408 Payroll Tax Expense 59,491
107 Federal Unemployment Tax Payable 360
The following transactions relating to payroll, payroll deductions, and payroll taxes
occurred during December:
Dec. 1. Issued Check No. 815 to Aberderas Insurance Company for $2,520, in payment
of the semiannual premium on the group medical insurance policy.
1. Issued Check No. 816 to Alvarez Bank for $8,131, in payment for $2,913 of
social security tax, $728 of Medicare tax, and $4,490 of employees’ federal
income tax due.
2. Issued Check No. 817 for $2,300 to Alvarez Bank to purchase U.S. savings bonds
for employees.
record follows:
Sales $14,500
Officers 7,100
Office 2,600 $24,200
Deductions:
Medicare tax 363
Savings bond deductions 1,150
Medical insurance deductions 420 8,782
Net amount $15,418
12. Issued Check No. 822 in payment of the net amount of the biweekly payroll.
12. Journalized the entry to record payroll taxes on employees’ earnings of Decem-
ber 12: social security tax, $1,452; Medicare tax, $363; state unemployment tax,
15. Issued Check No. 830 to Alvarez Bank for $7,938, in payment of $2,904 of social se-
curity tax, $726 of Medicare tax, and $4,308 of employees’ federal income tax due.
record follows:
Sales $14,250
Officers 7,250
Office 2,750 $24,250
Deductions:
Medicare tax 364
Savings bond deductions 1,150 8,377
Net amount $15,873
26. Issued Check No. 840 for the net amount of the biweekly payroll.
Dec. 26. Journalized the entry to record payroll taxes on employees’ earnings of December
26: social security tax, $1,455; Medicare tax, $364; state unemployment tax, $150;
federal unemployment tax, $40.
30. Issued Check No. 851 for $6,258 to State Department of Revenue, in payment of
employees’ state income tax due on December 31.
30. Issued Check No. 852 to Alvarez Bank for $2,300 to purchase U.S. savings bonds
for employees.
31. Paid $55,400 to the employee pension plan. The annual pension cost is $65,500.
(Record both the payment and the unfunded pension liability.)
Instructions
2. Journalize the following adjusting entries on December 31:
a. Salaries accrued: sales salaries, $4,275; officers salaries, $2,175; office salaries, $825.
The payroll taxes are immaterial and are not accrued.
b. Vacation pay, $13,350.
Comprehensive Problem 3
5. Total assets, Selected transactions completed by Kornett Company during its first fiscal year ended
$3,569,300 December 31, 2014, were as follows:
Jan. 3. Issued a check to establish a petty cash fund of $4,500.
Feb. 26. Replenished the petty cash fund, based on the following summary of petty cash
receipts: office supplies, $1,680; miscellaneous selling expense, $570; miscella-
neous administrative expense, $880.
Apr. 14. Purchased $31,300 of merchandise on account, terms 1/10, n/30. The perpetual
inventory system is used to account for inventory.
May 13. Paid the invoice of April 14 after the discount period had passed.
17. Received cash from daily cash sales for $21,200. The amount indicated by the
cash register was $21,240.
June 2. Received a 60-day, 8% note for $180,000 on the Ryanair account.
Aug. 1. Received amount owed on June 2 note, plus interest at the maturity date.
24. Received $7,600 on the Finley account and wrote off the remainder owed
on a $9,000 accounts receivable balance. (The allowance method is used in ac-
counting for uncollectible receivables.)
Sept. 15. Reinstated the Finley account written off on August 24 and received $1,400 cash
in full payment.
15. Purchased land by issuing a $670,000, 90-day note to Zahorik Co., which
discounted it at 9%.
Oct. 17. Sold office equipment in exchange for $135,000 cash plus receipt of a $100,000,
90-day, 9% note. The equipment had a cost of $320,000 and accumulated
depreciation of $64,000 as of October 17.
Nov. 30. Journalized the monthly payroll for November, based on the following data:
Salaries Deductions
Sales salaries $135,000 Income tax withheld $39,266
Office salaries 77,250 Social security tax withheld 12,735
$212,250 Medicare tax withheld 3,184
Unemployment tax rates:

State unemployment 5.4%
Federal unemployment 0.8%
Amount subject to unemployment taxes:
State unemployment $5,000
Federal unemployment 5,000
(continued)
Nov. 30. Journalized the employer’s payroll taxes on the payroll.

Dec. 14. Journalized the payment of the September 15 note at maturity.
31. The pension cost for the year was $190,400, of which $139,700 was paid to the
pension plan trustee.
Instructions
1. Journalize the selected transactions.
2. Based on the following data, prepare a bank reconciliation for December of the
current year:
a. Balance according to the bank statement at December 31, $283,000.
b. Balance according to the ledger at December 31, $245,410.
c. Checks outstanding at December 31, $68,540.
d. Deposit in transit, not recorded by bank, $29,500.
e. Bank debit memo for service charges, $750.
f. A check for $12,700 in payment of an invoice was incorrectly recorded in the
accounts as $12,000.
3. Based on the bank reconciliation prepared in (2), journalize the entry or entries to be
made by Kornett Company.
4. Based on the following selected data, journalize the adjusting entries as of December
31 of the current year:
a. Estimated uncollectible accounts at December 31, $16,000, based on an aging of
accounts receivable. The balance of Allowance for Doubtful Accounts at December
31 was $2,000 (debit).
b. The physical inventory on December 31 indicated an inventory shrinkage of $3,300.
c. Prepaid insurance expired during the year, $22,820.
d. Office supplies used during the year, $3,920.
e. Depreciation is computed as follows:
Depreciation
Residual Acquisition Useful Life Method
Asset Cost Value Date in Years Used
Buildings $900,000 $ 0 January 2 50 Double-declining-balance
Office Equip. 246,000 26,000 January 3 5 Straight-line
Store Equip. 112,000 12,000 July 1 10 Straight-line
f. A patent costing $48,000 when acquired on January 2 has a remaining legal life of
10 years and is expected to have value for eight years.
g. The cost of mineral rights was $546,000. Of the estimated deposit of 910,000 tons
of ore, 50,000 tons were mined and sold during the year.
h. Vacation pay expense for December, $10,500.
i. A product warranty was granted beginning December 1 and covering a one-year
period. The estimated cost is 4% of sales, which totaled $1,900,000 in December.
j. Interest was accrued on the note receivable received on October 17.
5. Based on the following information and the post-closing trial balance shown below,
prepare a balance sheet in report form at December 31 of the current year.
The merchandise inventory is stated at cost by the LIFO method.
The product warranty payable is a current liability.
Vacation pay payable:
Current liability $7,140
Long-term liability 3,360
The unfunded pension liability is a long-term liability.

Notes payable:
Current liability $ 70,000
Long-term liability 630,000
Kornett Company
Post-Closing Trial Balance
December 31, 2014
Debit Credit
Balances Balances
Petty Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,500
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 243,960
Notes Receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100,000
Accounts Receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 470,000
Allowance for Doubtful Accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . 16,000
Merchandise Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 320,000
Interest Receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,875
Prepaid Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45,640
Office Supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13,400
Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 654,925
Buildings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 900,000
Accumulated Depreciation—Buildings . . . . . . . . . . . . . . . . . . . . . . 36,000
Office Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 246,000
Accumulated Depreciation—Office Equipment . . . . . . . . . . . . . . 44,000
Store Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 112,000
Accumulated Depreciation—Store Equipment . . . . . . . . . . . . . . . 5,000
Mineral Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 546,000
Accumulated Depletion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30,000
Patents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42,000
Social Security Tax Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25,470
Medicare Tax Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,710
Employees Federal Income Tax Payable . . . . . . . . . . . . . . . . . . . . . . 40,000
State Unemployment Tax Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . 270
Federal Unemployment Tax Payable . . . . . . . . . . . . . . . . . . . . . . . . . 40
Salaries Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 157,000
Accounts Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 131,600
Interest Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28,000
Product Warranty Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76,000
Vacation Pay Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,500
Unfunded Pension Liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50,700
Notes Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 700,000
J. Kornett, Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,345,010
3,700,300 3,700,300
Cases & Projects
CP 11-1 Ethics and professional conduct in business

Tonya Latirno is a certified public accountant (CPA) and staff accountant for Kennedy
and Kennedy, a local CPA firm. It had been the policy of the firm to provide a holiday
bonus equal to two weeks’ salary to all employees. The firm’s new management team
announced on November 15 that a bonus equal to only one week’s salary would be made
available to employees this year. Tonya thought that this policy was unfair because she
and her coworkers planned on the full two-week bonus. The two-week bonus had been
given for 10 straight years, so it seemed as though the firm had breached an implied
commitment. Thus, Tonya decided that she would make up the lost bonus week by
working an extra six hours of overtime per week over the next five weeks until the end
of the year. Kennedy and Kennedy’s policy is to pay overtime at 150% of straight time.
Tonya’s supervisor was surprised to see overtime being reported, since there is gen-
erally very little additional or unusual client service demands at the end of the calendar
year. However, the overtime was not questioned, since firm employees are on the “honor
system” in reporting their overtime.
Discuss whether the firm is acting in an ethical manner by changing the bonus.
Is Tonya behaving in an ethical manner?
CP 11-2 Recognizing pension expense

The annual examination of Felton Company’s financial statements by its external public
accounting firm (auditors) is nearing completion. The following conversation took place
between the controller of Felton Company (Francie) and the audit manager from the
public accounting firm (Sumana).
Sumana: You know, Francie, we are about to wrap up our audit for this fiscal year. Yet, there is one item still to be resolved.
Francie: What’s that?
Sumana: Well, as you know, at the beginning of the year, Felton began a defined benefit pension plan. This plan
promises your employees an annual payment when they retire, using a formula based on their salaries at retirement
and their years of service. I believe that a pension expense should be recognized this year, equal to the amount of
pension earned by your employees.
Francie: Wait a minute. I think you have it all wrong. The company doesn’t have a pension expense until it actually
pays the pension in cash when the employee retires. After all, some of these employees may not reach retirement,
and if they don’t, the company doesn’t owe them anything.
Sumana: You’re not really seeing this the right way. The pension is earned by your employees during their working
years. You actually make the payment much later—when they retire. It’s like one long accrual—much like incurring
wages in one period and paying them in the next. Thus, I think that you should recognize the expense in the period
the pension is earned by the employees.
Francie: Let me see if I’ve got this straight. I should recognize an expense this period for something that may or may
not be paid to the employees in 20 or 30 years, when they finally retire. How am I supposed to determine what the
expense is for the current year? The amount of the final retirement depends on many uncertainties: salary levels,
employee longevity, mortality rates, and interest earned on investments to fund the pension. I don’t think that an
amount can be determined, even if I accepted your arguments.
Evaluate Sumana’s position. Is she right or is Francie correct?
CP 11-3 Ethics and professional conduct in business

Marvin Turner was discussing summer employment with Tina Song, president of Motown
Construction Service:
Tina: I’m glad that you’re thinking about joining us for the summer. We could certainly use the help.
Marvin: Sounds good. I enjoy outdoor work, and I could use the money to help with next year’s school expenses.
Tina: I’ve got a plan that can help you out on that. As you know, I’ll pay you $14 per hour, but in addition, I’d like
to pay you with cash. Since you’re only working for the summer, it really doesn’t make sense for me to go to the
trouble of formally putting you on our payroll system. In fact, I do some jobs for my clients on a strictly cash basis, so
it would be easy to just pay you that way.
Marvin: Well, that’s a bit unusual, but I guess money is money.
Tina: Yeah, not only that, it’s tax-free!
Marvin: What do you mean?
Tina: Didn’t you know? Any money that you receive in cash is not reported to the IRS on a W-2 form; therefore, the
IRS doesn’t know about the income—hence, it’s the same as tax-free earnings.
a. Why does Tina Song want to conduct business transactions using cash (not
check or credit card)?
b. How should Marvin respond to Tina’s suggestion?
CP 11-4 Payroll forms

Group Project
Internet Project Payroll accounting involves the use of government-supplied forms to account for payroll
taxes. Three common forms are the W-2, Form 940, and Form 941. Form a team with
three of your classmates and retrieve copies of each of these forms. They may be obtained
from a local IRS office, a library, or downloaded from the Internet at http://www.irs
.gov (go to forms and publications).
Briefly describe the purpose of each of the three forms.
CP 11-5 Contingent liabilities

Internet Project Altria Group, Inc., has over 12 pages dedicated to describing contingent liabilities in the notes
to recent financial statements. These pages include extensive descriptions of multiple con-
tingent liabilities. Use the Internet to research Altria Group, Inc., at http://www.altria.com.
a. What are the major business units of Altria Group?
b. Based on your understanding of this company, why would Altria Group require
11 pages of contingency disclosure?

Current Liabilities AK II

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Current Liabilities AK II

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Chapter

Current Liabilities and Payroll

At a Glance 11 Page 514

Describe and Current Liabilities

Accounts Payable as a Exhibit 1

Current Portion of Long-Term Debt

Fiscal year ending

Short-Term Notes Payable

Aug. 1 Accounts Payable—Murray Co. 1,000

Oct. 30 Notes Payable 1,000

Bowden Co. (Borrower) Coker Co. (Creditor)

Sept. 19 Cash 4,000

Dec. 18 Notes Payable 4,000

In some cases, a discounted note may be issued rather than an interest-bearing

Aug. 10 Cash 19,250

Nov. 8 Notes Payable 20,000

Example Exercise 11-1 Proceeds from Notes Payable

Follow My Example 11-1

Practice Exercises: PE 11-1A, PE 11-1B

Payroll and Payroll Taxes Determine

Liability for Employee Earnings

Deductions from Employee Earnings

Certificate John T. McGrath 381 48 9120

Table for Percentage Method of Withholding WEEKLY Payroll Period

Residents of New York

Example Exercise 11-2 Federal Income Tax Withholding

Follow My Example 11-2

Initial withholding from wage bracket in Exhibit 3. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $327.40

Practice Exercises: PE 11-2A, PE 11-2B

Earnings subject to 6% social security tax. . . . . . . . . . . . . . . . . . . . . . . . . . $1,462

Earnings subject to 1.5% Medicare tax. . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,462

Computing Employee Net Pay

Example Exercise 11-3 Employee Net Pay

Follow My Example 11-3

Practice Exercises: PE 11-3A, PE 11-3B

Liability for Employer’s Payroll Taxes

Describe payroll Accounting Systems for Payroll

Dec. 27 Sales Salaries Expense 11,122.00

Example Exercise 11-4 Journalize Period Payroll

Follow My Example 11-4

Practice Exercises: PE 11-4A, PE 11-4B

On December 27, McDermott Supply has the following payroll data:

Dec. 27 Payroll Tax Expense 1,210.67

Exhibit 5 Payroll Register

Employee Name Total Hours Regular Overtime Total

© Cengage Learning 2014

Example Exercise 11-5 Journalize Payroll Tax

Follow My Example 11-5

Practice Exercises: PE 11-5A, PE 11-5B

Employee’s Earnings Record

Deductions Withheld Paid Accounts Debited

© Cengage Learning 2014

Miscellaneous Deductions: UF––United Fund

provided annually to each employee as well as to the Social Security Administration.

a Employee’s social security number For Official Use Only ▶

McDermott Supply Co. 100,500.00 6,030.00

d Control number 9 10 Dependent care benefits

f Employee’s address and ZIP code

Form W-2 Wage and Tax Statement

Total Regular Overtime Total

© Cengage Learning 2014

An advantage of using a separate payroll bank account is that reconciling the

Computerized Payroll System

Describe payroll Accounting Systems for Payroll

6860 153111123 9385402

Contingent Liabilities Describe the